These 4 Measures Indicate That DMSLtd (KOSDAQ:068790) Is Using Debt Safely

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.' 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 note that DMS Co.,Ltd. (KOSDAQ:068790) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for DMSLtd

What Is DMSLtd's Net Debt?

As you can see below, DMSLtd had ₩71.8b of debt at December 2020, down from ₩86.5b a year prior. However, its balance sheet shows it holds ₩74.7b in cash, so it actually has ₩2.87b net cash.

How Healthy Is DMSLtd's Balance Sheet?

According to the last reported balance sheet, DMSLtd had liabilities of ₩140.8b due within 12 months, and liabilities of ₩2.07b due beyond 12 months. Offsetting this, it had ₩74.7b in cash and ₩27.5b in receivables that were due within 12 months. So it has liabilities totalling ₩40.6b more than its cash and near-term receivables, combined.

Of course, DMSLtd has a market capitalization of ₩206.8b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, DMSLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, DMSLtd grew its EBIT by 49% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is DMSLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While DMSLtd 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 most recent three years, DMSLtd recorded free cash flow worth 61% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

Although DMSLtd's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of ₩2.87b. And we liked the look of last year's 49% year-on-year EBIT growth. So we don't think DMSLtd's use of debt is risky. 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. We've identified 2 warning signs with DMSLtd , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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