Is Dongbang Transport Logistics (KRX:004140) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Dongbang Transport Logistics Co., Ltd. (KRX:004140) 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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Dongbang Transport Logistics

What Is Dongbang Transport Logistics's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Dongbang Transport Logistics had ₩220.4b of debt in September 2020, down from ₩320.0b, one year before. However, because it has a cash reserve of ₩17.4b, its net debt is less, at about ₩203.0b.

How Healthy Is Dongbang Transport Logistics' Balance Sheet?

We can see from the most recent balance sheet that Dongbang Transport Logistics had liabilities of ₩269.3b falling due within a year, and liabilities of ₩119.9b due beyond that. Offsetting these obligations, it had cash of ₩17.4b as well as receivables valued at ₩110.4b due within 12 months. So it has liabilities totalling ₩261.4b more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's ₩187.9b 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.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While we wouldn't worry about Dongbang Transport Logistics's net debt to EBITDA ratio of 4.3, we think its super-low interest cover of 1.1 times is a sign of high leverage. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Another concern for investors might be that Dongbang Transport Logistics's EBIT fell 15% in the last year. If things keep going like that, handling the debt will about as easy as bundling an angry house cat into its travel box. 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 Dongbang Transport Logistics will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Dongbang Transport Logistics saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Dongbang Transport Logistics's interest cover and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. And even its EBIT growth rate fails to inspire much confidence. We should also note that Infrastructure industry companies like Dongbang Transport Logistics commonly do use debt without problems. After considering the datapoints discussed, we think Dongbang Transport Logistics has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. 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. For example Dongbang Transport Logistics has 3 warning signs (and 1 which is potentially serious) 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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