Is Incheon City Gas (KRX:034590) A Risky Investment?

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.' 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. Importantly, Incheon City Gas Co., Ltd. (KRX:034590) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Incheon City Gas

What Is Incheon City Gas's Net Debt?

The chart below, which you can click on for greater detail, shows that Incheon City Gas had ₩17.0b in debt in September 2020; about the same as the year before. But on the other hand it also has ₩103.1b in cash, leading to a ₩86.1b net cash position.

A Look At Incheon City Gas' Liabilities

We can see from the most recent balance sheet that Incheon City Gas had liabilities of ₩58.3b falling due within a year, and liabilities of ₩92.0b due beyond that. On the other hand, it had cash of ₩103.1b and ₩36.4b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩10.8b.

Since publicly traded Incheon City Gas shares are worth a total of ₩101.4b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Incheon City Gas boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Incheon City Gas's saving grace is its low debt levels, because its EBIT has tanked 21% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Incheon City Gas's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Incheon 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. During the last three years, Incheon City Gas generated free cash flow amounting to a very robust 84% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

Although Incheon City Gas's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of ₩86.1b. And it impressed us with free cash flow of ₩7.5b, being 84% of its EBIT. So we are not troubled with Incheon City Gas's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Incheon City Gas (at least 1 which is concerning) , and understanding them should be part of your investment process.

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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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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