Is Daesung Energy (KRX:117580) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Daesung Energy Co., Ltd. (KRX:117580) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Daesung Energy

What Is Daesung Energy's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Daesung Energy had ₩97.0b of debt, an increase on ₩89.0b, over one year. However, it also had ₩44.6b in cash, and so its net debt is ₩52.4b.

How Healthy Is Daesung Energy's Balance Sheet?

According to the last reported balance sheet, Daesung Energy had liabilities of ₩165.4b due within 12 months, and liabilities of ₩116.1b due beyond 12 months. Offsetting these obligations, it had cash of ₩44.6b as well as receivables valued at ₩49.5b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩187.5b.

When you consider that this deficiency exceeds the company's ₩141.1b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With net debt sitting at just 1.1 times EBITDA, Daesung Energy is arguably pretty conservatively geared. And this view is supported by the solid interest coverage, with EBIT coming in at 7.1 times the interest expense over the last year. The good news is that Daesung Energy has increased its EBIT by 8.2% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But it is Daesung Energy's earnings that will influence how the balance sheet holds up in the future. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Daesung Energy created free cash flow amounting to 12% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

Mulling over Daesung Energy's attempt at staying on top of its total liabilities, we're certainly not enthusiastic. But on the bright side, its net debt to EBITDA is a good sign, and makes us more optimistic. We should also note that Gas Utilities industry companies like Daesung Energy commonly do use debt without problems. Once we consider all the factors above, together, it seems to us that Daesung Energy's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. Case in point: We've spotted 2 warning signs for Daesung Energy you should be aware of, and 1 of them shouldn't be ignored.

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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