HYUNDAI WIA (KRX:011210) Has A Somewhat Strained Balance Sheet

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 HYUNDAI WIA Corporation (KRX:011210) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for HYUNDAI WIA

What Is HYUNDAI WIA's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 HYUNDAI WIA had debt of ₩2.77t, up from ₩2.26t in one year. However, it also had ₩1.49t in cash, and so its net debt is ₩1.27t.

How Healthy Is HYUNDAI WIA's Balance Sheet?

According to the last reported balance sheet, HYUNDAI WIA had liabilities of ₩1.96t due within 12 months, and liabilities of ₩2.10t due beyond 12 months. Offsetting these obligations, it had cash of ₩1.49t as well as receivables valued at ₩1.65t due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩909.7b.

This deficit isn't so bad because HYUNDAI WIA is worth ₩2.61t, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While we wouldn't worry about HYUNDAI WIA's net debt to EBITDA ratio of 3.4, we think its super-low interest cover of 2.3 times is a sign of high leverage. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Even more troubling is the fact that HYUNDAI WIA actually let its EBIT decrease by 4.1% over the last year. If it keeps going like that paying off its debt will be like running on a treadmill -- a lot of effort for not much advancement. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine HYUNDAI WIA'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent two years, HYUNDAI WIA recorded free cash flow worth 54% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

HYUNDAI WIA's struggle to cover its interest expense with its EBIT had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. But on the bright side, its ability to to convert EBIT to free cash flow isn't too shabby at all. Taking the abovementioned factors together we do think HYUNDAI WIA's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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. We've identified 3 warning signs with HYUNDAI WIA (at least 1 which is potentially serious) , and understanding them should be part of your investment process.

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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