Is HDC Hyundai Development (KRX:294870) A Risky Investment?

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.' 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. As with many other companies HDC Hyundai Development Company (KRX:294870) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. 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 step when considering a company's debt levels is to consider its cash and debt together.

What Is HDC Hyundai Development's Net Debt?

As you can see below, at the end of December 2024, HDC Hyundai Development had ₩2.30t of debt, up from ₩2.09t a year ago. Click the image for more detail. However, because it has a cash reserve of ₩1.02t, its net debt is less, at about ₩1.29t.

A Look At HDC Hyundai Development's Liabilities

According to the last reported balance sheet, HDC Hyundai Development had liabilities of ₩3.51t due within 12 months, and liabilities of ₩837.3b due beyond 12 months. On the other hand, it had cash of ₩1.02t and ₩1.98t worth of receivables due within a year. So it has liabilities totalling ₩1.36t more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's ₩1.27t market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

Check out our latest analysis for HDC Hyundai Development

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

As it happens HDC Hyundai Development has a fairly concerning net debt to EBITDA ratio of 5.3 but very strong interest coverage of 1k. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Unfortunately, HDC Hyundai Development saw its EBIT slide 5.5% in the last twelve months. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine HDC Hyundai Development'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, HDC Hyundai Development 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 HDC Hyundai Development's net debt to EBITDA and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. We're quite clear that we consider HDC Hyundai Development to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that HDC Hyundai Development is showing 1 warning sign in our investment analysis , you should know about...

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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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.