Here's Why PC Direct (KOSDAQ:051380) Can Manage Its Debt Responsibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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, PC Direct, Inc. (KOSDAQ:051380) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for PC Direct

How Much Debt Does PC Direct Carry?

The image below, which you can click on for greater detail, shows that at December 2020 PC Direct had debt of ₩16.1b, up from ₩10.2b in one year. However, it does have ₩14.8b in cash offsetting this, leading to net debt of about ₩1.25b.

How Strong Is PC Direct's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that PC Direct had liabilities of ₩39.3b due within 12 months and liabilities of ₩718.1m due beyond that. On the other hand, it had cash of ₩14.8b and ₩39.5b worth of receivables due within a year. So it actually has ₩14.3b more liquid assets than total liabilities.

This excess liquidity suggests that PC Direct 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. But either way, PC Direct has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

PC Direct's net debt is only 0.17 times its EBITDA. And its EBIT covers its interest expense a whopping 21.2 times over. So we're pretty relaxed about its super-conservative use of debt. Also good is that PC Direct grew its EBIT at 20% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is PC Direct'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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Considering the last three years, PC Direct actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

The good news is that PC Direct's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. When we consider the range of factors above, it looks like PC Direct is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. 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. Be aware that PC Direct is showing 1 warning sign in our investment analysis , you should know about...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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