HD Hyundai Heavy IndustriesLtd (KRX:329180) Use Of Debt Could Be Considered Risky

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.' 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. Importantly, HD Hyundai Heavy Industries Co.,Ltd. (KRX:329180) does carry 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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for HD Hyundai Heavy IndustriesLtd

How Much Debt Does HD Hyundai Heavy IndustriesLtd Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2023 HD Hyundai Heavy IndustriesLtd had ₩3.13t of debt, an increase on ₩2.60t, over one year. However, it does have ₩1.06t in cash offsetting this, leading to net debt of about ₩2.07t.

How Strong Is HD Hyundai Heavy IndustriesLtd's Balance Sheet?

We can see from the most recent balance sheet that HD Hyundai Heavy IndustriesLtd had liabilities of ₩9.95t falling due within a year, and liabilities of ₩1.98t due beyond that. On the other hand, it had cash of ₩1.06t and ₩1.39t worth of receivables due within a year. So its liabilities total ₩9.48t more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of ₩11t, so it does suggest shareholders should keep an eye on HD Hyundai Heavy IndustriesLtd's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). 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).

While HD Hyundai Heavy IndustriesLtd's debt to EBITDA ratio (4.5) suggests that it uses some debt, its interest cover is very weak, at 2.2, suggesting high leverage. It seems that the business incurs large depreciation and amortisation charges, so maybe its debt load is heavier than it would first appear, since EBITDA is arguably a generous measure of earnings. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. However, the silver lining was that HD Hyundai Heavy IndustriesLtd achieved a positive EBIT of ₩178b in the last twelve months, an improvement on the prior year's loss. 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 HD Hyundai Heavy IndustriesLtd 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, HD Hyundai Heavy IndustriesLtd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both HD Hyundai Heavy IndustriesLtd's interest cover and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. Having said that, its ability to grow its EBIT isn't such a worry. Overall, it seems to us that HD Hyundai Heavy IndustriesLtd's balance sheet is really quite a risk to the business. 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. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of HD Hyundai Heavy IndustriesLtd's earnings per share history for free.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.