Does Dong A Eltek (KOSDAQ:088130) Have A Healthy Balance Sheet?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Dong A Eltek Co., Ltd. (KOSDAQ:088130) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Dong A Eltek

What Is Dong A Eltek's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Dong A Eltek had debt of ₩5.36b, up from ₩1.72b in one year. However, its balance sheet shows it holds ₩90.6b in cash, so it actually has ₩85.3b net cash.

How Strong Is Dong A Eltek's Balance Sheet?

The latest balance sheet data shows that Dong A Eltek had liabilities of ₩38.2b due within a year, and liabilities of ₩6.11b falling due after that. Offsetting this, it had ₩90.6b in cash and ₩16.6b in receivables that were due within 12 months. So it can boast ₩62.9b more liquid assets than total liabilities.

This excess liquidity is a great indication that Dong A Eltek's balance sheet is just as strong as racists are weak. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Dong A Eltek has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Dong A Eltek's saving grace is its low debt levels, because its EBIT has tanked 29% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Dong A Eltek will need earnings to service that debt. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Dong A Eltek 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. In the last three years, Dong A Eltek created free cash flow amounting to 15% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Dong A Eltek has net cash of ₩85.3b, as well as more liquid assets than liabilities. So we are not troubled with Dong A Eltek's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Take risks, for example - Dong A Eltek has 3 warning signs (and 1 which is concerning) we think you should know about.

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. 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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