Is Hyung Kuk F&B (KOSDAQ:189980) Using Too Much Debt?

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 Hyung Kuk F&B Co., Ltd. (KOSDAQ:189980) does use debt in its business. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Hyung Kuk F&B

What Is Hyung Kuk F&B's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Hyung Kuk F&B had ₩21.6b of debt, an increase on ₩19.4b, over one year. However, because it has a cash reserve of ₩14.8b, its net debt is less, at about ₩6.81b.

How Strong Is Hyung Kuk F&B's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hyung Kuk F&B had liabilities of ₩26.5b due within 12 months and liabilities of ₩2.17b due beyond that. Offsetting these obligations, it had cash of ₩14.8b as well as receivables valued at ₩12.3b due within 12 months. So it has liabilities totalling ₩1.64b more than its cash and near-term receivables, combined.

Having regard to Hyung Kuk F&B's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the ₩186.9b company is struggling for cash, we still think it's worth monitoring its balance sheet.

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.

Hyung Kuk F&B has a low net debt to EBITDA ratio of only 0.92. And its EBIT covers its interest expense a whopping 21.5 times over. So we're pretty relaxed about its super-conservative use of debt. In fact Hyung Kuk F&B's saving grace is its low debt levels, because its EBIT has tanked 53% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Hyung Kuk F&B will need earnings to service that debt. 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, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Considering the last three years, Hyung Kuk F&B actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

Neither Hyung Kuk F&B's ability to grow its EBIT nor its conversion of EBIT to free cash flow gave us confidence in its ability to take on more debt. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. Taking the abovementioned factors together we do think Hyung Kuk F&B's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 4 warning signs we've spotted with Hyung Kuk F&B (including 1 which is significant) .

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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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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