These 4 Measures Indicate That Hwaseung Enterprise (KRX:241590) Is Using Debt Extensively

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 note that Hwaseung Enterprise Co., Ltd. (KRX:241590) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. 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, 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 Enterprise

How Much Debt Does Hwaseung Enterprise Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Hwaseung Enterprise had ₩375.4b of debt, an increase on ₩333.4b, over one year. However, it does have ₩276.9b in cash offsetting this, leading to net debt of about ₩98.5b.

How Strong Is Hwaseung Enterprise's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hwaseung Enterprise had liabilities of ₩504.2b due within 12 months and liabilities of ₩98.8b due beyond that. Offsetting these obligations, it had cash of ₩276.9b as well as receivables valued at ₩96.9b due within 12 months. So it has liabilities totalling ₩229.2b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Hwaseung Enterprise has a market capitalization of ₩823.3b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Hwaseung Enterprise's low debt to EBITDA ratio of 0.76 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 5.8 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. We saw Hwaseung Enterprise grow its EBIT by 9.2% in the last twelve months. Whilst that hardly knocks our socks off it is a positive when it comes to debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Hwaseung Enterprise 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Hwaseung Enterprise saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Hwaseung Enterprise's struggle to convert EBIT to free cash flow had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. For example its net debt to EBITDA was refreshing. We think that Hwaseung Enterprise's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Hwaseung Enterprise you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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