Is LG Uplus (KRX:032640) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 LG Uplus Corp. (KRX:032640) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for LG Uplus

What Is LG Uplus's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 LG Uplus had debt of ₩5.83t, up from ₩3.76t in one year. On the flip side, it has ₩1.07t in cash leading to net debt of about ₩4.76t.

A Look At LG Uplus' Liabilities

The latest balance sheet data shows that LG Uplus had liabilities of ₩4.72t due within a year, and liabilities of ₩6.54t falling due after that. Offsetting these obligations, it had cash of ₩1.07t as well as receivables valued at ₩2.44t due within 12 months. So its liabilities total ₩7.75t more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's ₩5.46t market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

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

LG Uplus has a low net debt to EBITDA ratio of only 1.5. And its EBIT covers its interest expense a whopping 12.8 times over. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that LG Uplus has boosted its EBIT by 44%, thus reducing the spectre of future debt repayments. 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 LG Uplus can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, LG Uplus created free cash flow amounting to 9.6% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

While LG Uplus's level of total liabilities has us nervous. For example, its interest cover and EBIT growth rate give us some confidence in its ability to manage its debt. Taking the abovementioned factors together we do think LG Uplus's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. To that end, you should be aware of the 2 warning signs we've spotted with LG Uplus .

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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