Here's Why INNOX Advanced MaterialsLtd (KOSDAQ:272290) Can Manage Its Debt Responsibly

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 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. We note that INNOX Advanced Materials Co.,Ltd. (KOSDAQ:272290) 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. 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. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for INNOX Advanced MaterialsLtd

What Is INNOX Advanced MaterialsLtd's Debt?

As you can see below, INNOX Advanced MaterialsLtd had ₩123.7b of debt at September 2020, down from ₩140.9b a year prior. However, it also had ₩102.4b in cash, and so its net debt is ₩21.3b.

How Healthy Is INNOX Advanced MaterialsLtd's Balance Sheet?

According to the last reported balance sheet, INNOX Advanced MaterialsLtd had liabilities of ₩139.6b due within 12 months, and liabilities of ₩33.4b due beyond 12 months. Offsetting these obligations, it had cash of ₩102.4b as well as receivables valued at ₩76.2b due within 12 months. So it can boast ₩5.56b more liquid assets than total liabilities.

Having regard to INNOX Advanced MaterialsLtd's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the ₩440.1b company is short on cash, but still worth keeping an eye on the balance sheet.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

INNOX Advanced MaterialsLtd has a low net debt to EBITDA ratio of only 0.35. And its EBIT covers its interest expense a whopping 30.2 times over. So we're pretty relaxed about its super-conservative use of debt. On the other hand, INNOX Advanced MaterialsLtd saw its EBIT drop by 8.1% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine INNOX Advanced MaterialsLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, INNOX Advanced MaterialsLtd recorded free cash flow of 34% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

INNOX Advanced MaterialsLtd's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its EBIT growth rate does undermine this impression a bit. Looking at all the aforementioned factors together, it strikes us that INNOX Advanced MaterialsLtd can handle its debt fairly comfortably. 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. 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 instance, we've identified 1 warning sign for INNOX Advanced MaterialsLtd that you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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