The external fund manager backed by Berkshire Hathaway’s Charlie Munger, Li Lu, makes no bones about it when he says ‘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, HanmiGlobal Co., Ltd. (KRX:053690) does carry debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. The first step when considering a company’s debt levels is to consider its cash and debt together.
What Is HanmiGlobal’s Debt?
As you can see below, HanmiGlobal had ₩11.3b of debt at September 2019, down from ₩25.4b a year prior. However, its balance sheet shows it holds ₩53.7b in cash, so it actually has ₩42.4b net cash.
How Healthy Is HanmiGlobal’s Balance Sheet?
According to the last reported balance sheet, HanmiGlobal had liabilities of ₩46.2b due within 12 months, and liabilities of ₩11.5b due beyond 12 months. Offsetting this, it had ₩53.7b in cash and ₩26.7b in receivables that were due within 12 months. So it can boast ₩22.7b more liquid assets than total liabilities.
This excess liquidity suggests that HanmiGlobal is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Succinctly put, HanmiGlobal boasts net cash, so it’s fair to say it does not have a heavy debt load!
Better yet, HanmiGlobal grew its EBIT by 105% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But you can’t view debt in total isolation; since HanmiGlobal will need earnings to service that debt. 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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. HanmiGlobal may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, HanmiGlobal actually produced more free cash flow than EBIT. There’s nothing better than incoming cash when it comes to staying in your lenders’ good graces.
While we empathize with investors who find debt concerning, you should keep in mind that HanmiGlobal has net cash of ₩42.4b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of ₩30b, being 116% of its EBIT. When it comes to HanmiGlobal’s debt, we sufficiently relaxed that our mind turns to the jacuzzi. 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. Take risks, for example – HanmiGlobal has 2 warning signs we think you should be aware of.
If you’re interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned.
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