Is Pyung Hwa Industrial (KRX:090080) Using Debt In A Risky Way?

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. Importantly, Pyung Hwa Industrial Co., Ltd. (KRX:090080) does carry 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

See our latest analysis for Pyung Hwa Industrial

What Is Pyung Hwa Industrial's Net Debt?

As you can see below, Pyung Hwa Industrial had ₩93.3b of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. And it doesn't have much cash, so its net debt is about the same.

How Healthy Is Pyung Hwa Industrial's Balance Sheet?

According to the last reported balance sheet, Pyung Hwa Industrial had liabilities of ₩135.7b due within 12 months, and liabilities of ₩27.4b due beyond 12 months. Offsetting this, it had ₩1.74b in cash and ₩49.9b in receivables that were due within 12 months. So it has liabilities totalling ₩111.5b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the ₩68.4b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Pyung Hwa Industrial would probably need a major re-capitalization if its creditors were to demand repayment. There's no doubt that we learn most about debt from the balance sheet. But it is Pyung Hwa Industrial'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.

In the last year Pyung Hwa Industrial had a loss before interest and tax, and actually shrunk its revenue by 5.7%, to ₩330b. That's not what we would hope to see.

Caveat Emptor

Importantly, Pyung Hwa Industrial had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost ₩1.8b at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. It's fair to say the loss of ₩572m didn't encourage us either; we'd like to see a profit. In the meantime, we consider the stock to be risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Like risks, for instance. Every company has them, and we've spotted 2 warning signs for Pyung Hwa Industrial (of which 1 is potentially serious!) you should know about.

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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