Pyeong Hwa Automotive (KOSDAQ:043370) Takes On Some Risk With Its Use Of Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Pyeong Hwa Automotive Co., Ltd. (KOSDAQ:043370) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Pyeong Hwa Automotive

How Much Debt Does Pyeong Hwa Automotive Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Pyeong Hwa Automotive had debt of ₩145.0b, up from ₩86.6b in one year. But it also has ₩170.3b in cash to offset that, meaning it has ₩25.3b net cash.

How Healthy Is Pyeong Hwa Automotive's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Pyeong Hwa Automotive had liabilities of ₩358.4b due within 12 months and liabilities of ₩34.6b due beyond that. Offsetting this, it had ₩170.3b in cash and ₩208.5b in receivables that were due within 12 months. So its liabilities total ₩14.2b more than the combination of its cash and short-term receivables.

Since publicly traded Pyeong Hwa Automotive shares are worth a total of ₩241.3b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Pyeong Hwa Automotive boasts net cash, so it's fair to say it does not have a heavy debt load!

Importantly, Pyeong Hwa Automotive's EBIT fell a jaw-dropping 89% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Pyeong Hwa Automotive can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Pyeong Hwa Automotive 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, Pyeong Hwa Automotive burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

We could understand if investors are concerned about Pyeong Hwa Automotive's liabilities, but we can be reassured by the fact it has has net cash of ₩25.3b. Despite its cash we think that Pyeong Hwa Automotive seems to struggle to grow its EBIT, so we are wary of the stock. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 4 warning signs for Pyeong Hwa Automotive that you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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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