We Think Sungwoo Hitech (KOSDAQ:015750) Is Taking Some Risk With Its Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 Sungwoo Hitech Co., Ltd. (KOSDAQ:015750) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. 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.

View our latest analysis for Sungwoo Hitech

What Is Sungwoo Hitech's Net Debt?

As you can see below, at the end of March 2024, Sungwoo Hitech had ₩1.63t of debt, up from ₩1.45t a year ago. Click the image for more detail. However, because it has a cash reserve of ₩540.4b, its net debt is less, at about ₩1.09t.

A Look At Sungwoo Hitech's Liabilities

According to the last reported balance sheet, Sungwoo Hitech had liabilities of ₩1.97t due within 12 months, and liabilities of ₩658.8b due beyond 12 months. On the other hand, it had cash of ₩540.4b and ₩697.2b worth of receivables due within a year. So it has liabilities totalling ₩1.39t more than its cash and near-term receivables, combined.

This deficit casts a shadow over the ₩741.5b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Sungwoo Hitech would likely require a major re-capitalisation if it had to pay its creditors today.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Sungwoo Hitech has net debt worth 2.3 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 3.7 times the interest expense. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. Notably, Sungwoo Hitech's EBIT launched higher than Elon Musk, gaining a whopping 103% on last year. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Sungwoo Hitech's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Sungwoo Hitech reported free cash flow worth 19% 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

We'd go so far as to say Sungwoo Hitech's level of total liabilities was disappointing. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. Looking at the bigger picture, it seems clear to us that Sungwoo Hitech's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Sungwoo Hitech has 2 warning signs we think you should be aware of.

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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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