David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, MK Electron Co., Ltd. (KOSDAQ:033160) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
View our latest analysis for MK Electron
How Much Debt Does MK Electron Carry?
As you can see below, at the end of September 2020, MK Electron had ₩335.7b of debt, up from ₩317.8b a year ago. Click the image for more detail. However, it does have ₩25.2b in cash offsetting this, leading to net debt of about ₩310.5b.
How Healthy Is MK Electron's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that MK Electron had liabilities of ₩374.8b due within 12 months and liabilities of ₩747.6b due beyond that. On the other hand, it had cash of ₩25.2b and ₩141.7b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩955.4b.
This deficit casts a shadow over the ₩252.8b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, MK Electron would likely require a major re-capitalisation if it had to pay its creditors today.
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).
MK Electron has net debt to EBITDA of 3.0 suggesting it uses a fair bit of leverage to boost returns. On the plus side, its EBIT was 8.0 times its interest expense, and its net debt to EBITDA, was quite high, at 3.0. Shareholders should be aware that MK Electron's EBIT was down 44% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. The balance sheet is clearly the area to focus on when you are analysing debt. But it is MK Electron's earnings that will influence how the balance sheet holds up in the future. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. In the last three years, MK Electron created free cash flow amounting to 18% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.
Our View
On the face of it, MK Electron's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Taking into account all the aforementioned factors, it looks like MK Electron has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. 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. For example MK Electron has 2 warning signs (and 1 which is a bit unpleasant) we think you should know about.
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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About KOSDAQ:A033160
MK Electron
Develops, manufactures, and markets semiconductor materials in Korea, Taiwan, China, and Southeast Asia.
Slightly overvalued very low.
