Here's Why Hwashin Precision Engineering (KOSDAQ:126640) Can Manage Its Debt Responsibly

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.' 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. We can see that Hwashin Precision Engineering Co., Ltd. (KOSDAQ:126640) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Hwashin Precision Engineering

What Is Hwashin Precision Engineering's Net Debt?

As you can see below, at the end of September 2020, Hwashin Precision Engineering had ₩26.7b of debt, up from ₩20.0b a year ago. Click the image for more detail. But on the other hand it also has ₩28.2b in cash, leading to a ₩1.48b net cash position.

How Strong Is Hwashin Precision Engineering's Balance Sheet?

The latest balance sheet data shows that Hwashin Precision Engineering had liabilities of ₩53.3b due within a year, and liabilities of ₩15.7b falling due after that. Offsetting this, it had ₩28.2b in cash and ₩31.2b in receivables that were due within 12 months. So its liabilities total ₩9.63b more than the combination of its cash and short-term receivables.

Of course, Hwashin Precision Engineering has a market capitalization of ₩67.8b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Hwashin Precision Engineering boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Hwashin Precision Engineering saw its EBIT drop by 8.6% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But it is Hwashin Precision Engineering'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Hwashin Precision Engineering may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Hwashin Precision Engineering produced sturdy free cash flow equating to 75% 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 Hwashin Precision Engineering does have more liabilities than liquid assets, it also has net cash of ₩1.48b. The cherry on top was that in converted 75% of that EBIT to free cash flow, bringing in ₩6.0b. So we are not troubled with Hwashin Precision Engineering's debt use. 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. Like risks, for instance. Every company has them, and we've spotted 3 warning signs for Hwashin Precision Engineering (of which 1 is a bit concerning!) you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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