Stock Analysis

We Think BHI (KOSDAQ:083650) Is Taking Some Risk With Its Debt

KOSDAQ:A083650
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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. We note that BHI Co., Ltd. (KOSDAQ:083650) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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Why Does Debt Bring Risk?

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. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for BHI

How Much Debt Does BHI Carry?

The image below, which you can click on for greater detail, shows that BHI had debt of ₩169.1b at the end of September 2020, a reduction from ₩189.0b over a year. However, because it has a cash reserve of ₩23.4b, its net debt is less, at about ₩145.7b.

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KOSDAQ:A083650 Debt to Equity History March 1st 2021

A Look At BHI's Liabilities

The latest balance sheet data shows that BHI had liabilities of ₩225.0b due within a year, and liabilities of ₩65.7b falling due after that. Offsetting these obligations, it had cash of ₩23.4b as well as receivables valued at ₩102.6b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩164.7b.

The deficiency here weighs heavily on the ₩72.3b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, BHI would probably need a major re-capitalization if its creditors were to demand repayment.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

BHI shareholders face the double whammy of a high net debt to EBITDA ratio (9.2), and fairly weak interest coverage, since EBIT is just 0.79 times the interest expense. This means we'd consider it to have a heavy debt load. One redeeming factor for BHI is that it turned last year's EBIT loss into a gain of ₩7.0b, over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is BHI's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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 the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, BHI actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

To be frank both BHI's interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. We're quite clear that we consider BHI to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. To that end, you should learn about the 2 warning signs we've spotted with BHI (including 1 which makes us a bit uncomfortable) .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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