Does Huvitz (KOSDAQ:065510) Have A Healthy Balance Sheet?

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Huvitz Co., Ltd. (KOSDAQ:065510) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Huvitz

What Is Huvitz's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Huvitz had debt of ₩51.1b, up from ₩38.6b in one year. However, it does have ₩22.1b in cash offsetting this, leading to net debt of about ₩29.1b.

How Healthy Is Huvitz's Balance Sheet?

We can see from the most recent balance sheet that Huvitz had liabilities of ₩51.1b falling due within a year, and liabilities of ₩19.7b due beyond that. Offsetting these obligations, it had cash of ₩22.1b as well as receivables valued at ₩14.6b due within 12 months. So its liabilities total ₩34.1b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Huvitz has a market capitalization of ₩95.8b, 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 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Huvitz's net debt is sitting at a very reasonable 2.4 times its EBITDA, while its EBIT covered its interest expense just 6.7 times last year. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Importantly, Huvitz's EBIT fell a jaw-dropping 41% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 Huvitz can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Huvitz's free cash flow amounted to 30% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Huvitz's EBIT growth rate was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example, its interest cover is relatively strong. We should also note that Medical Equipment industry companies like Huvitz commonly do use debt without problems. When we consider all the factors discussed, it seems to us that Huvitz is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 4 warning signs for Huvitz (2 are concerning!) that you should be aware of before investing here.

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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