Daesung Holdings (KRX:016710) Seems To Use Debt Quite Sensibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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, Daesung Holdings Co., Ltd. (KRX:016710) does carry debt. But the more important question is: how much risk is that debt creating?

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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Daesung Holdings

What Is Daesung Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Daesung Holdings had ₩206.2b of debt, an increase on ₩193.3b, over one year. However, it does have ₩129.8b in cash offsetting this, leading to net debt of about ₩76.4b.

How Strong Is Daesung Holdings' Balance Sheet?

The latest balance sheet data shows that Daesung Holdings had liabilities of ₩356.2b due within a year, and liabilities of ₩243.3b falling due after that. On the other hand, it had cash of ₩129.8b and ₩183.4b worth of receivables due within a year. So its liabilities total ₩286.3b more than the combination of its cash and short-term receivables.

Daesung Holdings has a market capitalization of ₩483.5b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Looking at its net debt to EBITDA of 1.3 and interest cover of 6.5 times, it seems to us that Daesung Holdings is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Fortunately, Daesung Holdings grew its EBIT by 9.8% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Daesung Holdings 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. In the last three years, Daesung Holdings's free cash flow amounted to 44% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Daesung Holdings's net debt to EBITDA was a real positive on this analysis, as was its EBIT growth rate. Having said that, its level of total liabilities somewhat sensitizes us to potential future risks to the balance sheet. We would also note that Gas Utilities industry companies like Daesung Holdings commonly do use debt without problems. When we consider all the factors mentioned above, we do feel a bit cautious about Daesung Holdings's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. Over time, share prices tend to follow earnings per share, so if you're interested in Daesung Holdings, you may well want to click here to check an interactive graph of its earnings per share history.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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