Is Hanwha Ocean (KRX:042660) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, Hanwha Ocean Co., Ltd. (KRX:042660) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Hanwha Ocean

What Is Hanwha Ocean's Net Debt?

As you can see below, at the end of September 2024, Hanwha Ocean had ₩4.89t of debt, up from ₩2.31t a year ago. Click the image for more detail. On the flip side, it has ₩1.04t in cash leading to net debt of about ₩3.85t.

How Healthy Is Hanwha Ocean's Balance Sheet?

The latest balance sheet data shows that Hanwha Ocean had liabilities of ₩9.90t due within a year, and liabilities of ₩2.28t falling due after that. Offsetting this, it had ₩1.04t in cash and ₩711.3b in receivables that were due within 12 months. So it has liabilities totalling ₩10t more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of ₩11t, so it does suggest shareholders should keep an eye on Hanwha Ocean's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (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).

Hanwha Ocean shareholders face the double whammy of a high net debt to EBITDA ratio (20.3), and fairly weak interest coverage, since EBIT is just 0.34 times the interest expense. This means we'd consider it to have a heavy debt load. One redeeming factor for Hanwha Ocean is that it turned last year's EBIT loss into a gain of ₩22b, over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Hanwha Ocean can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, Hanwha Ocean burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Hanwha Ocean's interest cover and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But at least its EBIT growth rate is not so bad. Taking into account all the aforementioned factors, it looks like Hanwha Ocean has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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. Be aware that Hanwha Ocean is showing 3 warning signs in our investment analysis , and 2 of those are a bit unpleasant...

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.