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.' 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, Seoul City Gas Co., Ltd. (KRX:017390) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
View our latest analysis for Seoul City Gas
What Is Seoul City Gas's Net Debt?
As you can see below, Seoul City Gas had ₩11.6b of debt at December 2020, down from ₩12.7b a year prior. However, its balance sheet shows it holds ₩616.2b in cash, so it actually has ₩604.6b net cash.
How Healthy Is Seoul City Gas' Balance Sheet?
According to the last reported balance sheet, Seoul City Gas had liabilities of ₩383.3b due within 12 months, and liabilities of ₩271.9b due beyond 12 months. On the other hand, it had cash of ₩616.2b and ₩247.1b worth of receivables due within a year. So it actually has ₩208.1b more liquid assets than total liabilities.
This surplus strongly suggests that Seoul City Gas has a rock-solid balance sheet (and the debt is of no concern whatsoever). With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, Seoul City Gas boasts net cash, so it's fair to say it does not have a heavy debt load!
The modesty of its debt load may become crucial for Seoul City Gas if management cannot prevent a repeat of the 24% cut to EBIT over the last year. 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 you can't view debt in total isolation; since Seoul City Gas 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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Seoul City Gas 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, Seoul City Gas reported free cash flow worth 5.5% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.
Summing up
While it is always sensible to investigate a company's debt, in this case Seoul City Gas has ₩604.6b in net cash and a decent-looking balance sheet. So we are not troubled with Seoul City Gas's debt use. 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. We've identified 1 warning sign with Seoul City Gas , and understanding them should be part of your investment process.
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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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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About KOSE:A017390
Excellent balance sheet average dividend payer.
