We Think MCNEX (KOSDAQ:097520) Is Taking Some Risk With Its Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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, MCNEX Co., Ltd (KOSDAQ:097520) 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. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for MCNEX

What Is MCNEX's Debt?

As you can see below, at the end of September 2020, MCNEX had ₩203.6b of debt, up from ₩73.2b a year ago. Click the image for more detail. On the flip side, it has ₩87.0b in cash leading to net debt of about ₩116.6b.

How Healthy Is MCNEX's Balance Sheet?

We can see from the most recent balance sheet that MCNEX had liabilities of ₩349.0b falling due within a year, and liabilities of ₩22.9b due beyond that. On the other hand, it had cash of ₩87.0b and ₩204.5b worth of receivables due within a year. So it has liabilities totalling ₩80.5b more than its cash and near-term receivables, combined.

Given MCNEX has a market capitalization of ₩918.7b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

MCNEX's net debt is only 0.89 times its EBITDA. And its EBIT covers its interest expense a whopping 26.6 times over. So we're pretty relaxed about its super-conservative use of debt. In fact MCNEX's saving grace is its low debt levels, because its EBIT has tanked 26% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if MCNEX 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, MCNEX burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Neither MCNEX's ability to grow its EBIT nor its conversion of EBIT to free cash flow gave us confidence in its ability to take on more debt. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. Taking the abovementioned factors together we do think MCNEX's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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 instance, we've identified 5 warning signs for MCNEX (2 are significant) you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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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