Here's Why Wooshin Systems (KRX:017370) Has A Meaningful Debt Burden

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Wooshin Systems Co., Ltd. (KRX:017370) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Wooshin Systems

How Much Debt Does Wooshin Systems Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Wooshin Systems had debt of ₩148.5b, up from ₩116.0b in one year. However, because it has a cash reserve of ₩61.2b, its net debt is less, at about ₩87.3b.

How Healthy Is Wooshin Systems' Balance Sheet?

We can see from the most recent balance sheet that Wooshin Systems had liabilities of ₩189.1b falling due within a year, and liabilities of ₩35.3b due beyond that. Offsetting these obligations, it had cash of ₩61.2b as well as receivables valued at ₩103.1b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩60.1b.

This is a mountain of leverage relative to its market capitalization of ₩72.8b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 0.36 times and a disturbingly high net debt to EBITDA ratio of 6.7 hit our confidence in Wooshin Systems like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. However, the silver lining was that Wooshin Systems achieved a positive EBIT of ₩1.5b in the last twelve months, an improvement on the prior year's loss. There's no doubt that we learn most about debt from the balance sheet. But it is Wooshin Systems'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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, Wooshin Systems actually produced more free cash flow than EBIT over the last year. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Neither Wooshin Systems's ability to cover its interest expense with its EBIT nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But its conversion of EBIT to free cash flow tells a very different story, and suggests some resilience. Taking the abovementioned factors together we do think Wooshin Systems's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. We've identified 4 warning signs with Wooshin Systems (at least 2 which shouldn't be ignored) , and understanding them should be part of your investment process.

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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