Here's Why Koryo Electronics (GTSM:8032) Can Manage Its Debt Responsibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Koryo Electronics Co., Ltd. (GTSM:8032) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. 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, 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 Koryo Electronics

How Much Debt Does Koryo Electronics Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Koryo Electronics had debt of NT$407.7m, up from NT$38.3m in one year. But on the other hand it also has NT$557.7m in cash, leading to a NT$150.0m net cash position.

How Healthy Is Koryo Electronics's Balance Sheet?

We can see from the most recent balance sheet that Koryo Electronics had liabilities of NT$832.1m falling due within a year, and liabilities of NT$124.3m due beyond that. On the other hand, it had cash of NT$557.7m and NT$775.8m worth of receivables due within a year. So it can boast NT$377.1m more liquid assets than total liabilities.

This excess liquidity is a great indication that Koryo Electronics's balance sheet is just as strong as racists are weak. Having regard to this fact, we think its balance sheet is just as strong as misogynists are weak. Simply put, the fact that Koryo Electronics has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Koryo Electronics's load is not too heavy, because its EBIT was down 46% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is Koryo Electronics'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Koryo Electronics 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, Koryo Electronics actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Koryo Electronics has net cash of NT$150.0m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of NT$118m, being 132% of its EBIT. So we don't think Koryo Electronics's use of debt is risky. 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. Take risks, for example - Koryo Electronics has 4 warning signs (and 1 which is a bit concerning) we think you should know about.

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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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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