Is Hwacheon Machine Tool (KRX:000850) Using Too Much Debt?

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 can see that Hwacheon Machine Tool Co. Ltd (KRX:000850) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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.

Check out our latest analysis for Hwacheon Machine Tool

What Is Hwacheon Machine Tool's Net Debt?

The image below, which you can click on for greater detail, shows that Hwacheon Machine Tool had debt of ₩17.1b at the end of September 2020, a reduction from ₩25.8b over a year. However, it does have ₩95.6b in cash offsetting this, leading to net cash of ₩78.5b.

How Healthy Is Hwacheon Machine Tool's Balance Sheet?

According to the last reported balance sheet, Hwacheon Machine Tool had liabilities of ₩44.7b due within 12 months, and liabilities of ₩36.1b due beyond 12 months. Offsetting these obligations, it had cash of ₩95.6b as well as receivables valued at ₩24.8b due within 12 months. So it actually has ₩39.6b more liquid assets than total liabilities.

This surplus liquidity suggests that Hwacheon Machine Tool's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that Hwacheon Machine Tool has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But it is Hwacheon Machine Tool'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.

In the last year Hwacheon Machine Tool had a loss before interest and tax, and actually shrunk its revenue by 23%, to ₩166b. That makes us nervous, to say the least.

So How Risky Is Hwacheon Machine Tool?

While Hwacheon Machine Tool lost money on an earnings before interest and tax (EBIT) level, it actually booked a paper profit of ₩2.5b. So when you consider it has net cash, along with the statutory profit, the stock probably isn't as risky as it might seem, at least in the short term. There's no doubt the next few years will be crucial to how the business matures. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Hwacheon Machine Tool is showing 4 warning signs in our investment analysis , and 1 of those makes us a bit uncomfortable...

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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