Is Hanshin Machinery (KRX:011700) A Risky Investment?

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.' 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. We can see that Hanshin Machinery Co., Ltd. (KRX:011700) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Hanshin Machinery

What Is Hanshin Machinery's Debt?

The chart below, which you can click on for greater detail, shows that Hanshin Machinery had ₩1.72b in debt in September 2020; about the same as the year before. However, its balance sheet shows it holds ₩19.7b in cash, so it actually has ₩18.0b net cash.

A Look At Hanshin Machinery's Liabilities

Zooming in on the latest balance sheet data, we can see that Hanshin Machinery had liabilities of ₩7.64b due within 12 months and liabilities of ₩2.71b due beyond that. On the other hand, it had cash of ₩19.7b and ₩24.2b worth of receivables due within a year. So it actually has ₩33.6b more liquid assets than total liabilities.

This surplus liquidity suggests that Hanshin Machinery'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. Succinctly put, Hanshin Machinery boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that Hanshin Machinery saw its EBIT decline by 7.3% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Hanshin Machinery'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Hanshin Machinery has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Hanshin Machinery burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

While it is always sensible to investigate a company's debt, in this case Hanshin Machinery has ₩18.0b in net cash and a decent-looking balance sheet. So we are not troubled with Hanshin Machinery's debt use. 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. To that end, you should learn about the 3 warning signs we've spotted with Hanshin Machinery (including 1 which is a bit concerning) .

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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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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