We Think HCT (KOSDAQ:072990) Can Stay On Top Of Its Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We note that HCT Co., Ltd. (KOSDAQ:072990) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for HCT

What Is HCT's Debt?

As you can see below, HCT had ₩16.9b of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has ₩14.5b in cash leading to net debt of about ₩2.40b.

A Look At HCT's Liabilities

Zooming in on the latest balance sheet data, we can see that HCT had liabilities of ₩22.6b due within 12 months and liabilities of ₩5.34b due beyond that. On the other hand, it had cash of ₩14.5b and ₩11.8b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩1.61b.

Having regard to HCT's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the ₩96.7b company is short on cash, but still worth keeping an eye on the balance sheet.

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).

HCT has a low net debt to EBITDA ratio of only 0.14. And its EBIT easily covers its interest expense, being 32.7 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Another good sign is that HCT has been able to increase its EBIT by 24% in twelve months, making it easier to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But it is HCT's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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 that EBIT is backed by free cash flow. In the last three years, HCT created free cash flow amounting to 19% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

HCT's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. Taking all this data into account, it seems to us that HCT takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Take risks, for example - HCT has 1 warning sign we think you should be aware of.

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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This article by Simply Wall St is general in nature. 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.
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