Is Korea Computer (KOSDAQ:054040) Using Too Much Debt?

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.' 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 note that Korea Computer Inc. (KOSDAQ:054040) 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 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. 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. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Korea Computer

What Is Korea Computer's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Korea Computer had ₩21.0b of debt in December 2020, down from ₩26.3b, one year before. However, its balance sheet shows it holds ₩46.5b in cash, so it actually has ₩25.5b net cash.

A Look At Korea Computer's Liabilities

The latest balance sheet data shows that Korea Computer had liabilities of ₩27.6b due within a year, and liabilities of ₩13.7b falling due after that. Offsetting these obligations, it had cash of ₩46.5b as well as receivables valued at ₩28.5b due within 12 months. So it actually has ₩33.7b more liquid assets than total liabilities.

This excess liquidity is a great indication that Korea Computer's balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Korea Computer boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Korea Computer has boosted its EBIT by 40%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is Korea Computer's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Korea Computer has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last two years, Korea Computer generated free cash flow amounting to a very robust 99% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Korea Computer has ₩25.5b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of ₩632m, being 99% of its EBIT. At the end of the day we're not concerned about Korea Computer's debt. 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. Case in point: We've spotted 4 warning signs for Korea Computer you should be aware of, and 1 of them makes us a bit uncomfortable.

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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