These 4 Measures Indicate That SK D&D (KRX:210980) Is Using Debt Extensively

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies SK D&D Co. Ltd. (KRX:210980) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for SK D&D

What Is SK D&D's Debt?

As you can see below, SK D&D had ₩954.8b of debt at June 2020, down from ₩1.07t a year prior. However, it also had ₩266.5b in cash, and so its net debt is ₩688.3b.

A Look At SK D&D's Liabilities

The latest balance sheet data shows that SK D&D had liabilities of ₩836.3b due within a year, and liabilities of ₩389.8b falling due after that. On the other hand, it had cash of ₩266.5b and ₩50.9b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩908.7b.

Given this deficit is actually higher than the company's market capitalization of ₩842.2b, we think shareholders really should watch SK D&D's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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).

SK D&D's debt is 4.0 times its EBITDA, and its EBIT cover its interest expense 5.7 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Pleasingly, SK D&D is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 359% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if SK D&D can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, SK D&D burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Mulling over SK D&D's attempt at converting EBIT to free cash flow, we're certainly not enthusiastic. But at least it's pretty decent at growing its EBIT; that's encouraging. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making SK D&D stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that SK D&D is showing 3 warning signs in our investment analysis , and 1 of those is 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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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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