Here's Why HWASEUNG IndustriesLtd (KRX:006060) Has A Meaningful Debt Burden

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. We note that HWASEUNG Industries Co.,Ltd. (KRX:006060) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out 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 September 2020 HWASEUNG IndustriesLtd had debt of ₩528.9b, up from ₩490.9b in one year. On the flip side, it has ₩340.1b in cash leading to net debt of about ₩188.8b.

How Strong Is HWASEUNG IndustriesLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that HWASEUNG IndustriesLtd had liabilities of ₩649.8b due within 12 months and liabilities of ₩140.0b due beyond that. Offsetting these obligations, it had cash of ₩340.1b as well as receivables valued at ₩123.6b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩326.2b.

This deficit is considerable relative to its market capitalization of ₩376.8b, so it does suggest shareholders should keep an eye on HWASEUNG 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.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

Looking at its net debt to EBITDA of 1.2 and interest cover of 5.8 times, it seems to us that HWASEUNG IndustriesLtd is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. We saw HWASEUNG IndustriesLtd grow its EBIT by 5.9% in the last twelve months. That's far from incredible but it is a good thing, when it comes to paying off debt. There's no doubt that we learn most about debt from the balance sheet. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs 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

Mulling over HWASEUNG IndustriesLtd's attempt at converting EBIT to free cash flow, we're certainly not enthusiastic. But at least it's pretty decent at managing its debt, based on its EBITDA,; that's encouraging. Once we consider all the factors above, together, it seems to us that HWASEUNG IndustriesLtd's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with HWASEUNG IndustriesLtd .

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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