Here's Why HJ Shipbuilding & Construction (KRX:097230) Is Weighed Down By Its Debt Load

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.' 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 HJ Shipbuilding & Construction Co., Ltd. (KRX:097230) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. 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. 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 HJ Shipbuilding & Construction's Net Debt?

The image below, which you can click on for greater detail, shows that HJ Shipbuilding & Construction had debt of ₩477.2b at the end of September 2024, a reduction from ₩663.1b over a year. However, it also had ₩232.5b in cash, and so its net debt is ₩244.7b.

How Healthy Is HJ Shipbuilding & Construction's Balance Sheet?

The latest balance sheet data shows that HJ Shipbuilding & Construction had liabilities of ₩1.49t due within a year, and liabilities of ₩335.9b falling due after that. On the other hand, it had cash of ₩232.5b and ₩135.3b worth of receivables due within a year. So it has liabilities totalling ₩1.45t more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the ₩569.6b 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 definitely think shareholders need to watch this one closely. After all, HJ Shipbuilding & Construction would likely require a major re-capitalisation if it had to pay its creditors today.

View our latest analysis for HJ Shipbuilding & Construction

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While HJ Shipbuilding & Construction's debt to EBITDA ratio (4.5) suggests that it uses some debt, its interest cover is very weak, at 0.81, suggesting high leverage. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. One redeeming factor for HJ Shipbuilding & Construction is that it turned last year's EBIT loss into a gain of ₩25b, over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is HJ Shipbuilding & Construction'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. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, HJ Shipbuilding & Construction saw substantial negative free cash flow, in total. 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.

Our View

To be frank both HJ Shipbuilding & Construction's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. Having said that, its ability to grow its EBIT isn't such a worry. Taking into account all the aforementioned factors, it looks like HJ Shipbuilding & Construction has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for HJ Shipbuilding & Construction you should know about.

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.