Is Hanwha Systems (KRX:272210) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Hanwha Systems Co., Ltd. (KRX:272210) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Hanwha Systems

What Is Hanwha Systems's Net Debt?

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, it does have ₩581.4b in cash offsetting this, leading to net cash of ₩441.5b.

How Strong Is Hanwha Systems' Balance Sheet?

We can see from the most recent balance sheet that Hanwha Systems had liabilities of ₩1.45t falling due within a year, and liabilities of ₩349.3b due beyond that. Offsetting these obligations, it had cash of ₩581.4b as well as receivables valued at ₩117.8b due within 12 months. So its liabilities total ₩1.10t more than the combination of its cash and short-term receivables.

Hanwha Systems has a market capitalization of ₩2.07t, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept 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. And it impressed us with free cash flow of ₩236b, being 232% of its EBIT. So we don't think Hanwha Systems's use of debt is risky. 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. For example, we've discovered 2 warning signs for Hanwha Systems that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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