The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies TOP Engineering Co., Ltd (KOSDAQ:065130) makes use of debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is TOP Engineering's Debt?
As you can see below, at the end of September 2020, TOP Engineering had ₩99.7b of debt, up from ₩83.5b a year ago. Click the image for more detail. However, it also had ₩47.9b in cash, and so its net debt is ₩51.8b.
How Healthy Is TOP Engineering's Balance Sheet?
We can see from the most recent balance sheet that TOP Engineering had liabilities of ₩330.3b falling due within a year, and liabilities of ₩8.89b due beyond that. Offsetting these obligations, it had cash of ₩47.9b as well as receivables valued at ₩245.0b due within 12 months. So its liabilities total ₩46.3b more than the combination of its cash and short-term receivables.
This deficit isn't so bad because TOP Engineering is worth ₩157.5b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since TOP Engineering will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
In the last year TOP Engineering had a loss before interest and tax, and actually shrunk its revenue by 10%, to ₩1.2t. We would much prefer see growth.
While TOP Engineering's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost ₩5.2b at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through ₩17b of cash over the last year. So in short it's a really risky stock. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for TOP Engineering that you should be aware of before investing here.
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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