HansolHomeDeco.Co.Ltd (KRX:025750) Takes On Some Risk With Its Use Of Debt

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, HansolHomeDeco.Co.Ltd. (KRX:025750) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for HansolHomeDeco.Co.Ltd

What Is HansolHomeDeco.Co.Ltd's Debt?

The image below, which you can click on for greater detail, shows that HansolHomeDeco.Co.Ltd had debt of ₩93.6b at the end of September 2020, a reduction from ₩101.4b over a year. However, because it has a cash reserve of ₩11.9b, its net debt is less, at about ₩81.7b.

A Look At HansolHomeDeco.Co.Ltd's Liabilities

Zooming in on the latest balance sheet data, we can see that HansolHomeDeco.Co.Ltd had liabilities of ₩77.4b due within 12 months and liabilities of ₩67.4b due beyond that. Offsetting these obligations, it had cash of ₩11.9b as well as receivables valued at ₩31.9b due within 12 months. So its liabilities total ₩101.1b more than the combination of its cash and short-term receivables.

HansolHomeDeco.Co.Ltd has a market capitalization of ₩171.6b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 0.27 times and a disturbingly high net debt to EBITDA ratio of 9.2 hit our confidence in HansolHomeDeco.Co.Ltd like a one-two punch to the gut. The debt burden here is substantial. Worse, HansolHomeDeco.Co.Ltd's EBIT was down 58% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since HansolHomeDeco.Co.Ltd 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.

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. Happily for any shareholders, HansolHomeDeco.Co.Ltd actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

On the face of it, HansolHomeDeco.Co.Ltd's interest cover left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that HansolHomeDeco.Co.Ltd's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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 HansolHomeDeco.Co.Ltd (including 2 which are a bit concerning) .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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