Mercury (KOSDAQ:100590) Has A Pretty 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.' 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. As with many other companies Mercury Corporation (KOSDAQ:100590) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Mercury

What Is Mercury's Debt?

As you can see below, at the end of September 2020, Mercury had ₩22.7b of debt, up from ₩3.79b a year ago. Click the image for more detail. However, its balance sheet shows it holds ₩51.6b in cash, so it actually has ₩28.9b net cash.

How Healthy Is Mercury's Balance Sheet?

According to the last reported balance sheet, Mercury had liabilities of ₩15.7b due within 12 months, and liabilities of ₩27.3b due beyond 12 months. Offsetting these obligations, it had cash of ₩51.6b as well as receivables valued at ₩10.3b due within 12 months. So it actually has ₩18.9b more liquid assets than total liabilities.

This surplus suggests that Mercury has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Mercury has more cash than debt is arguably a good indication that it can manage its debt safely.

Shareholders should be aware that Mercury's EBIT was down 96% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Mercury 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Mercury may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Mercury actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While it is always sensible to investigate a company's debt, in this case Mercury has ₩28.9b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of -₩6.5b, being 106% of its EBIT. So we are not troubled with Mercury's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Mercury (at least 1 which is concerning) , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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