Raonsecure (KOSDAQ:042510) Has A Somewhat Strained Balance Sheet

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. Importantly, Raonsecure Co., Ltd. (KOSDAQ:042510) does carry debt. But the more important question is: how much risk is that debt creating?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Raonsecure

What Is Raonsecure's Debt?

You can click the graphic below for the historical numbers, but it shows that Raonsecure had ₩11.9b of debt in September 2020, down from ₩12.8b, one year before. But on the other hand it also has ₩22.8b in cash, leading to a ₩10.9b net cash position.

How Strong Is Raonsecure's Balance Sheet?

The latest balance sheet data shows that Raonsecure had liabilities of ₩25.1b due within a year, and liabilities of ₩1.84b falling due after that. Offsetting this, it had ₩22.8b in cash and ₩6.52b in receivables that were due within 12 months. So it actually has ₩2.39b more liquid assets than total liabilities.

This surplus suggests that Raonsecure has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Raonsecure boasts net cash, so it's fair to say it does not have a heavy debt load!

Shareholders should be aware that Raonsecure's EBIT was down 98% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But it is Raonsecure'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. Raonsecure may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Raonsecure created free cash flow amounting to 19% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Raonsecure has ₩10.9b in net cash and a decent-looking balance sheet. So while Raonsecure does not have a great balance sheet, it's certainly not too bad. 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 Raonsecure is showing 3 warning signs in our investment analysis , and 2 of those are a bit concerning...

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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