Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Eagle Veterinary Technology Co.,Ltd (KOSDAQ:044960) does use debt in its business. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Eagle Veterinary TechnologyLtd Carry?
The image below, which you can click on for greater detail, shows that Eagle Veterinary TechnologyLtd had debt of ₩5.98b at the end of September 2020, a reduction from ₩7.69b over a year. On the flip side, it has ₩3.78b in cash leading to net debt of about ₩2.20b.
A Look At Eagle Veterinary TechnologyLtd's Liabilities
The latest balance sheet data shows that Eagle Veterinary TechnologyLtd had liabilities of ₩7.69b due within a year, and liabilities of ₩3.33b falling due after that. Offsetting these obligations, it had cash of ₩3.78b as well as receivables valued at ₩8.78b due within 12 months. So it actually has ₩1.54b more liquid assets than total liabilities.
This state of affairs indicates that Eagle Veterinary TechnologyLtd's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the ₩99.6b company is short on cash, but still worth keeping an eye on the balance sheet.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Eagle Veterinary TechnologyLtd's net debt is only 0.47 times its EBITDA. And its EBIT covers its interest expense a whopping 11.5 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In addition to that, we're happy to report that Eagle Veterinary TechnologyLtd has boosted its EBIT by 73%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Eagle Veterinary TechnologyLtd will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Eagle Veterinary TechnologyLtd recorded free cash flow worth a fulsome 97% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.
Happily, Eagle Veterinary TechnologyLtd's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. And the good news does not stop there, as its EBIT growth rate also supports that impression! We think Eagle Veterinary TechnologyLtd is no more beholden to its lenders, than the birds are to birdwatchers. To our minds it has a healthy happy balance sheet. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 3 warning signs we've spotted with Eagle Veterinary TechnologyLtd (including 1 which is a bit concerning) .
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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