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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Douzone Bizon Co., Ltd. (KRX:012510) does use debt in its business. But should shareholders be worried about its use of debt?
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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
Check out our latest analysis for Douzone Bizon
How Much Debt Does Douzone Bizon Carry?
The chart below, which you can click on for greater detail, shows that Douzone Bizon had ₩268.0b in debt in September 2020; about the same as the year before. However, it does have ₩45.7b in cash offsetting this, leading to net debt of about ₩222.3b.
How Healthy Is Douzone Bizon's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Douzone Bizon had liabilities of ₩101.8b due within 12 months and liabilities of ₩274.4b due beyond that. Offsetting these obligations, it had cash of ₩45.7b as well as receivables valued at ₩51.4b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩279.1b.
Given Douzone Bizon has a market capitalization of ₩2.94t, it's hard to believe these liabilities pose much threat. 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Douzone Bizon's net debt to EBITDA ratio of about 2.2 suggests only moderate use of debt. And its commanding EBIT of 10.8 times its interest expense, implies the debt load is as light as a peacock feather. If Douzone Bizon can keep growing EBIT at last year's rate of 18% over the last year, then it will find its debt load easier to manage. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Douzone Bizon can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
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. Over the last three years, Douzone Bizon saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
Our View
Based on what we've seen Douzone Bizon is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its interest cover. When we consider all the factors mentioned above, we do feel a bit cautious about Douzone Bizon's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Consider risks, for instance. Every company has them, and we've spotted 2 warning signs for Douzone Bizon you should know about.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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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About KOSE:A012510
Proven track record with adequate balance sheet.
