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

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that Hanwha Systems Co., Ltd. (KRX:272210) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Hanwha Systems

How Much Debt Does Hanwha Systems Carry?

As you can see below, at the end of June 2024, Hanwha Systems had ₩509.2b of debt, up from ₩110.0b a year ago. Click the image for more detail. But it also has ₩548.7b in cash to offset that, meaning it has ₩39.5b net cash.

A Look At Hanwha Systems' Liabilities

According to the last reported balance sheet, Hanwha Systems had liabilities of ₩2.17t due within 12 months, and liabilities of ₩645.3b due beyond 12 months. On the other hand, it had cash of ₩548.7b and ₩292.5b worth of receivables due within a year. So its liabilities total ₩1.97t more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Hanwha Systems has a market capitalization of ₩5.28t, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Hanwha Systems boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Hanwha Systems grew its EBIT by 149% 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 it is future earnings, more than anything, that will determine Hanwha Systems's ability to maintain a healthy balance sheet going forward. 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. Looking at the most recent three years, Hanwha Systems recorded free cash flow of 47% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

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 ₩39.5b. And we liked the look of last year's 149% year-on-year EBIT growth. So we don't have any problem with Hanwha Systems's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Hanwha Systems , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.