Is Micro Contact Solution (KOSDAQ:098120) A Risky Investment?

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. As with many other companies Micro Contact Solution Co., Ltd. (KOSDAQ:098120) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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 Micro Contact Solution

How Much Debt Does Micro Contact Solution Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Micro Contact Solution had ₩3.43b of debt, an increase on ₩511.0m, over one year. But on the other hand it also has ₩15.6b in cash, leading to a ₩12.1b net cash position.

How Strong Is Micro Contact Solution's Balance Sheet?

According to the last reported balance sheet, Micro Contact Solution had liabilities of ₩7.00b due within 12 months, and liabilities of ₩1.37b due beyond 12 months. Offsetting these obligations, it had cash of ₩15.6b as well as receivables valued at ₩5.51b due within 12 months. So it can boast ₩12.7b more liquid assets than total liabilities.

This excess liquidity suggests that Micro Contact Solution is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Micro Contact Solution has more cash than debt is arguably a good indication that it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, Micro Contact Solution turned things around in the last 12 months, delivering and EBIT of ₩2.0b. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Micro Contact Solution'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Micro Contact Solution 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 year, Micro Contact Solution actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Micro Contact Solution has net cash of ₩12.1b, as well as more liquid assets than liabilities. The cherry on top was that in converted 265% of that EBIT to free cash flow, bringing in ₩5.3b. So is Micro Contact Solution'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. For example Micro Contact Solution has 2 warning signs (and 1 which is concerning) we think 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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