Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies CUCKOO Homesys Co., Ltd (KRX:284740) makes use of debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
What Is CUCKOO Homesys's Debt?
As you can see below, CUCKOO Homesys had ₩5.10b of debt at September 2020, down from ₩37.1b a year prior. However, it does have ₩30.1b in cash offsetting this, leading to net cash of ₩25.0b.
A Look At CUCKOO Homesys' Liabilities
The latest balance sheet data shows that CUCKOO Homesys had liabilities of ₩140.3b due within a year, and liabilities of ₩23.2b falling due after that. Offsetting this, it had ₩30.1b in cash and ₩97.5b in receivables that were due within 12 months. So its liabilities total ₩35.9b more than the combination of its cash and short-term receivables.
Of course, CUCKOO Homesys has a market capitalization of ₩861.0b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, CUCKOO Homesys also has more cash than debt, so we're pretty confident it can manage its debt safely.
On top of that, CUCKOO Homesys grew its EBIT by 43% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine CUCKOO Homesys's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While CUCKOO Homesys has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, CUCKOO Homesys reported free cash flow worth 13% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.
While it is always sensible to look at a company's total liabilities, it is very reassuring that CUCKOO Homesys has ₩25.0b in net cash. And we liked the look of last year's 43% year-on-year EBIT growth. So is CUCKOO Homesys's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Take risks, for example - CUCKOO Homesys has 1 warning sign we think you should be aware of.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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