Is Daejoo Electronic Materials (KOSDAQ:078600) A Risky Investment?

Warren Buffett famously said, '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. As with many other companies Daejoo Electronic Materials Co., Ltd. (KOSDAQ:078600) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Daejoo Electronic Materials

How Much Debt Does Daejoo Electronic Materials Carry?

The image below, which you can click on for greater detail, shows that at June 2024 Daejoo Electronic Materials had debt of ₩288.2b, up from ₩227.9b in one year. However, it also had ₩98.1b in cash, and so its net debt is ₩190.2b.

How Healthy Is Daejoo Electronic Materials' Balance Sheet?

We can see from the most recent balance sheet that Daejoo Electronic Materials had liabilities of ₩343.3b falling due within a year, and liabilities of ₩36.7b due beyond that. Offsetting these obligations, it had cash of ₩98.1b as well as receivables valued at ₩54.1b due within 12 months. So its liabilities total ₩227.8b more than the combination of its cash and short-term receivables.

Of course, Daejoo Electronic Materials has a market capitalization of ₩1.62t, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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

Daejoo Electronic Materials has a rather high debt to EBITDA ratio of 6.9 which suggests a meaningful debt load. However, its interest coverage of 3.5 is reasonably strong, which is a good sign. However, it should be some comfort for shareholders to recall that Daejoo Electronic Materials actually grew its EBIT by a hefty 224%, over the last 12 months. If it can keep walking that path it will be in a position to shed its debt with relative ease. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Daejoo Electronic Materials 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Daejoo Electronic Materials burned a lot of cash. 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

Daejoo Electronic Materials's conversion of EBIT to free cash flow and net debt to EBITDA definitely weigh on it, in our esteem. But its EBIT growth rate tells a very different story, and suggests some resilience. Looking at all the angles mentioned above, it does seem to us that Daejoo Electronic Materials is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. For example, we've discovered 3 warning signs for Daejoo Electronic Materials (2 don't sit too well with us!) that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.