Sungwoo Hitech (KOSDAQ:015750) Use Of Debt Could Be Considered Risky

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We can see that Sungwoo Hitech Co., Ltd. (KOSDAQ:015750) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Sungwoo Hitech

What Is Sungwoo Hitech's Net Debt?

As you can see below, Sungwoo Hitech had ₩1.47t of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has ₩384.0b in cash leading to net debt of about ₩1.09t.

How Healthy Is Sungwoo Hitech's Balance Sheet?

The latest balance sheet data shows that Sungwoo Hitech had liabilities of ₩1.72t due within a year, and liabilities of ₩517.7b falling due after that. On the other hand, it had cash of ₩384.0b and ₩548.0b worth of receivables due within a year. So its liabilities total ₩1.30t more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the ₩314.0b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Sungwoo Hitech would likely require a major re-capitalisation if it had to pay its creditors today.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While we wouldn't worry about Sungwoo Hitech's net debt to EBITDA ratio of 4.5, we think its super-low interest cover of 0.088 times is a sign of high leverage. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Worse, Sungwoo Hitech's EBIT was down 96% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. When analysing debt levels, the balance sheet is the obvious place to start. But it is Sungwoo Hitech'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Sungwoo Hitech reported free cash flow worth 12% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

To be frank both Sungwoo Hitech's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And even its net debt to EBITDA fails to inspire much confidence. Considering all the factors previously mentioned, we think that Sungwoo Hitech really is carrying too much debt. To our minds, that means the stock is rather high risk, and probably one to avoid; but to each their own (investing) style. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Sungwoo Hitech (2 are potentially serious!) that you should be aware of before investing here.

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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