Stock Analysis

Rorze Systems (KOSDAQ:071280) Seems To Use Debt Quite Sensibly

KOSDAQ:A071280
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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We can see that Rorze Systems Corporation (KOSDAQ:071280) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Rorze Systems

What Is Rorze Systems's Debt?

The image below, which you can click on for greater detail, shows that Rorze Systems had debt of ₩24.6b at the end of December 2020, a reduction from ₩30.6b over a year. However, because it has a cash reserve of ₩16.4b, its net debt is less, at about ₩8.17b.

debt-equity-history-analysis
KOSDAQ:A071280 Debt to Equity History April 12th 2021

A Look At Rorze Systems' Liabilities

The latest balance sheet data shows that Rorze Systems had liabilities of ₩35.3b due within a year, and liabilities of ₩9.83b falling due after that. Offsetting this, it had ₩16.4b in cash and ₩13.9b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩14.7b.

Of course, Rorze Systems has a market capitalization of ₩95.8b, 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.

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).

Rorze Systems has a low net debt to EBITDA ratio of only 0.69. And its EBIT covers its interest expense a whopping 58.1 times over. So we're pretty relaxed about its super-conservative use of debt. Even more impressive was the fact that Rorze Systems grew its EBIT by 117% over twelve months. That boost will make it even easier to pay down debt going forward. 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 Rorze Systems will need earnings to service that debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last two years, Rorze Systems saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

The good news is that Rorze Systems's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. All these things considered, it appears that Rorze Systems can comfortably handle its current debt levels. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. 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. Be aware that Rorze Systems is showing 1 warning sign in our investment analysis , you should know about...

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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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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