These 4 Measures Indicate That Dong A Eltek (KOSDAQ:088130) Is Using Debt Reasonably Well

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Dong A Eltek Co., Ltd. (KOSDAQ:088130) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Dong A Eltek

How Much Debt Does Dong A Eltek Carry?

As you can see below, at the end of September 2020, Dong A Eltek had ₩5.36b of debt, up from ₩1.72b a year ago. Click the image for more detail. However, its balance sheet shows it holds ₩90.6b in cash, so it actually has ₩85.3b net cash.

How Healthy Is Dong A Eltek's Balance Sheet?

According to the last reported balance sheet, Dong A Eltek had liabilities of ₩38.2b due within 12 months, and liabilities of ₩6.11b due beyond 12 months. On the other hand, it had cash of ₩90.6b and ₩16.6b worth of receivables due within a year. 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 almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. 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.

The modesty of its debt load may become crucial for Dong A Eltek if management cannot prevent a repeat of the 29% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. 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. Over the last three years, Dong A Eltek reported free cash flow worth 15% of its EBIT, which is really quite low. 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 don't have any problem with Dong A Eltek's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Dong A Eltek (1 is potentially serious) you should be aware of.

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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