We Think Korea Electric Power Industrial Development (KRX:130660) Can Stay On Top Of Its Debt

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Korea Electric Power Industrial Development Co., Ltd (KRX:130660) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Korea Electric Power Industrial Development

What Is Korea Electric Power Industrial Development's Net Debt?

As you can see below, at the end of September 2020, Korea Electric Power Industrial Development had ₩10.4b of debt, up from ₩6.64b a year ago. Click the image for more detail. But on the other hand it also has ₩32.4b in cash, leading to a ₩22.0b net cash position.

How Strong Is Korea Electric Power Industrial Development's Balance Sheet?

According to the last reported balance sheet, Korea Electric Power Industrial Development had liabilities of ₩47.7b due within 12 months, and liabilities of ₩34.1b due beyond 12 months. Offsetting this, it had ₩32.4b in cash and ₩59.6b in receivables that were due within 12 months. So it can boast ₩10.2b more liquid assets than total liabilities.

This short term liquidity is a sign that Korea Electric Power Industrial Development could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Korea Electric Power Industrial Development has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, Korea Electric Power Industrial Development saw its EBIT drop by 4.6% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. But it is Korea Electric Power Industrial Development'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. While Korea Electric Power Industrial Development 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. During the last three years, Korea Electric Power Industrial Development produced sturdy free cash flow equating to 62% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Korea Electric Power Industrial Development has net cash of ₩22.0b, as well as more liquid assets than liabilities. So is Korea Electric Power Industrial Development's debt a risk? It doesn't seem so to us. 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. To that end, you should learn about the 3 warning signs we've spotted with Korea Electric Power Industrial Development (including 2 which make us uncomfortable) .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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