Hanwha Systems (KRX:272210) Seems To Use Debt Quite Sensibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Hanwha Systems Co., Ltd. (KRX:272210) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Hanwha Systems

How Much Debt Does Hanwha Systems Carry?

The image below, which you can click on for greater detail, shows that Hanwha Systems had debt of ₩139.9b at the end of September 2020, a reduction from ₩147.2b over a year. However, its balance sheet shows it holds ₩581.4b in cash, so it actually has ₩441.5b net cash.

How Healthy Is Hanwha Systems's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hanwha Systems had liabilities of ₩1.45t due within 12 months and liabilities of ₩349.3b due beyond that. On the other hand, it had cash of ₩581.4b and ₩117.8b worth of receivables due within a year. So its liabilities total ₩1.10t more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of ₩1.47t. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, Hanwha Systems boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that Hanwha Systems grew its EBIT by 15% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Hanwha Systems 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Hanwha Systems 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. Over the last two years, Hanwha Systems 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.

Summing up

Although Hanwha Systems's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of ₩441.5b. The cherry on top was that in converted 232% of that EBIT to free cash flow, bringing in ₩236b. So we don't have any problem with Hanwha Systems's use of debt. 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. Case in point: We've spotted 1 warning sign for Hanwha Systems you should be aware of.

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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