These 4 Measures Indicate That Seoul City Gas (KRX:017390) Is Using Debt Safely

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.' 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. We can see that Seoul City Gas Co., Ltd. (KRX:017390) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Seoul City Gas

What Is Seoul City Gas's Net Debt?

As you can see below, Seoul City Gas had ₩11.9b of debt at September 2020, down from ₩12.9b a year prior. However, its balance sheet shows it holds ₩695.6b in cash, so it actually has ₩683.8b net cash.

How Strong Is Seoul City Gas's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Seoul City Gas had liabilities of ₩200.5b due within 12 months and liabilities of ₩276.0b due beyond that. Offsetting these obligations, it had cash of ₩695.6b as well as receivables valued at ₩79.5b due within 12 months. So it actually has ₩298.6b 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). Having regard to this fact, we think its balance sheet is just as strong as misogynists are weak. Simply put, the fact that Seoul City Gas has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for Seoul City Gas if management cannot prevent a repeat of the 41% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Seoul City Gas 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. While Seoul City Gas has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Seoul City Gas actually produced more free cash flow than EBIT over the last three years. 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 Seoul City Gas has ₩683.8b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 158% of that EBIT to free cash flow, bringing in ₩19b. So we don't think Seoul City Gas's use of debt is risky. 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. For example, we've discovered 1 warning sign for Seoul City Gas that you should be aware of before investing here.

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.

If you’re looking to trade Seoul City Gas, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.