Health Check: How Prudently Does Muhak (KRX:033920) Use Debt?

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.' 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. Importantly, Muhak Co., Ltd. (KRX:033920) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 Muhak

How Much Debt Does Muhak Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Muhak had ₩52.0b of debt, an increase on ₩42.0b, over one year. But it also has ₩62.0b in cash to offset that, meaning it has ₩10.0b net cash.

How Healthy Is Muhak's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Muhak had liabilities of ₩122.1b due within 12 months and liabilities of ₩14.1b due beyond that. Offsetting these obligations, it had cash of ₩62.0b as well as receivables valued at ₩25.2b due within 12 months. So its liabilities total ₩49.0b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Muhak has a market capitalization of ₩181.3b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Muhak also has more cash than debt, so we're pretty confident it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But it is Muhak'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.

In the last year Muhak had a loss before interest and tax, and actually shrunk its revenue by 16%, to ₩148b. That's not what we would hope to see.

So How Risky Is Muhak?

While Muhak lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow ₩5.2b. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. With revenue growth uninspiring, we'd really need to see some positive EBIT before mustering much enthusiasm for this business. 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, we've discovered 1 warning sign for Muhak that you should be aware of before investing here.

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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