Does HDC HOLDINGSLtd (KRX:012630) Have A Healthy Balance Sheet?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that HDC HOLDINGS CO.,Ltd (KRX:012630) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for HDC HOLDINGSLtd

What Is HDC HOLDINGSLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 HDC HOLDINGSLtd had ₩2.74t of debt, an increase on ₩785.4b, over one year. However, it does have ₩3.14t in cash offsetting this, leading to net cash of ₩396.9b.

How Healthy Is HDC HOLDINGSLtd's Balance Sheet?

We can see from the most recent balance sheet that HDC HOLDINGSLtd had liabilities of ₩2.99t falling due within a year, and liabilities of ₩2.25t due beyond that. Offsetting this, it had ₩3.14t in cash and ₩949.7b in receivables that were due within 12 months. So its liabilities total ₩1.16t more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the ₩605.8b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, HDC HOLDINGSLtd would likely require a major re-capitalisation if it had to pay its creditors today. Given that HDC HOLDINGSLtd has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

In addition to that, we're happy to report that HDC HOLDINGSLtd has boosted its EBIT by 59%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since HDC HOLDINGSLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. HDC HOLDINGSLtd may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, HDC HOLDINGSLtd's free cash flow amounted to 35% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing up

Although HDC HOLDINGSLtd's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of ₩396.9b. And it impressed us with its EBIT growth of 59% over the last year. So although we see some areas for improvement, we're not too worried about HDC HOLDINGSLtd's balance sheet. 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 instance, we've identified 3 warning signs for HDC HOLDINGSLtd (2 are concerning) you should be aware of.

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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