Fine DNC (KOSDAQ:049120) Is Making Moderate Use Of Debt

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.' 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 Fine DNC Co., Ltd. (KOSDAQ:049120) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Fine DNC

How Much Debt Does Fine DNC Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Fine DNC had ₩37.3b of debt, an increase on ₩32.6b, over one year. However, it also had ₩6.06b in cash, and so its net debt is ₩31.3b.

How Healthy Is Fine DNC's Balance Sheet?

According to the last reported balance sheet, Fine DNC had liabilities of ₩40.2b due within 12 months, and liabilities of ₩14.7b due beyond 12 months. Offsetting these obligations, it had cash of ₩6.06b as well as receivables valued at ₩19.8b due within 12 months. So its liabilities total ₩29.0b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of ₩47.7b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Fine DNC will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Fine DNC reported revenue of ₩78b, which is a gain of 30%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

Despite the top line growth, Fine DNC still had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable ₩5.6b at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled ₩13b in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. 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. To that end, you should learn about the 4 warning signs we've spotted with Fine DNC (including 2 which shouldn't be ignored) .

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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