David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We can see that hyungji Elite Co., Ltd. (KRX:093240) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for hyungji Elite
What Is hyungji Elite's Debt?
The image below, which you can click on for greater detail, shows that hyungji Elite had debt of ₩23.4b at the end of September 2020, a reduction from ₩25.2b over a year. However, it does have ₩13.4b in cash offsetting this, leading to net debt of about ₩10.0b.
A Look At hyungji Elite's Liabilities
We can see from the most recent balance sheet that hyungji Elite had liabilities of ₩40.6b falling due within a year, and liabilities of ₩11.4b due beyond that. Offsetting these obligations, it had cash of ₩13.4b as well as receivables valued at ₩31.5b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩7.14b.
Given hyungji Elite has a market capitalization of ₩102.1b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Even though hyungji Elite's debt is only 2.1, its interest cover is really very low at 1.8. This does suggest the company is paying fairly high interest rates. Either way there's no doubt the stock is using meaningful leverage. We also note that hyungji Elite improved its EBIT from a last year's loss to a positive ₩2.4b. There's no doubt that we learn most about debt from the balance sheet. But it is hyungji Elite'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, hyungji Elite actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Our View
The good news is that hyungji Elite's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its interest cover. Looking at all the aforementioned factors together, it strikes us that hyungji Elite can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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. Be aware that hyungji Elite is showing 3 warning signs in our investment analysis , you should know about...
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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About KOSE:A093240
hyungji Elite
Engages in the provides school uniforms primarily under the Elite brand in South Korea.
Solid track record with excellent balance sheet.
