Stock Analysis

Does HWASEUNG IndustriesLtd (KRX:006060) Have A Healthy Balance Sheet?

KOSE:A006060
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The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 HWASEUNG Industries Co.,Ltd. (KRX:006060) makes use of debt. But is this debt a concern to shareholders?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for HWASEUNG IndustriesLtd

How Much Debt Does HWASEUNG IndustriesLtd Carry?

The image below, which you can click on for greater detail, shows that at December 2020 HWASEUNG IndustriesLtd had debt of ₩532.9b, up from ₩500.7b in one year. On the flip side, it has ₩323.8b in cash leading to net debt of about ₩209.1b.

debt-equity-history-analysis
KOSE:A006060 Debt to Equity History April 5th 2021

How Strong Is HWASEUNG IndustriesLtd's Balance Sheet?

We can see from the most recent balance sheet that HWASEUNG IndustriesLtd had liabilities of ₩713.3b falling due within a year, and liabilities of ₩92.9b due beyond that. Offsetting these obligations, it had cash of ₩323.8b as well as receivables valued at ₩162.5b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩319.9b.

This deficit is considerable relative to its market capitalization of ₩418.0b, so it does suggest shareholders should keep an eye on HWASEUNG IndustriesLtd's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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).

While HWASEUNG IndustriesLtd's low debt to EBITDA ratio of 1.4 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 5.5 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Importantly, HWASEUNG IndustriesLtd's EBIT fell a jaw-dropping 27% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But it is HWASEUNG IndustriesLtd's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, HWASEUNG 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 HWASEUNG IndustriesLtd's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But on the bright side, its net debt to EBITDA is a good sign, and makes us more optimistic. We're quite clear that we consider HWASEUNG IndustriesLtd to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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 - HWASEUNG IndustriesLtd has 2 warning signs we think you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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