These 4 Measures Indicate That HansolHomeDeco.Co.Ltd (KRX:025750) Is Using Debt Extensively

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. We note that HansolHomeDeco.Co.Ltd. (KRX:025750) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for HansolHomeDeco.Co.Ltd

How Much Debt Does HansolHomeDeco.Co.Ltd Carry?

As you can see below, HansolHomeDeco.Co.Ltd had ₩84.6b of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. However, it does have ₩9.77b in cash offsetting this, leading to net debt of about ₩74.8b.

How Healthy Is HansolHomeDeco.Co.Ltd's Balance Sheet?

According to the last reported balance sheet, HansolHomeDeco.Co.Ltd had liabilities of ₩76.1b due within 12 months, and liabilities of ₩64.4b due beyond 12 months. Offsetting this, it had ₩9.77b in cash and ₩36.2b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩94.5b.

This deficit isn't so bad because HansolHomeDeco.Co.Ltd is worth ₩178.5b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. 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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 0.23 times and a disturbingly high net debt to EBITDA ratio of 9.1 hit our confidence in HansolHomeDeco.Co.Ltd like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. One redeeming factor for HansolHomeDeco.Co.Ltd is that it turned last year's EBIT loss into a gain of ₩539m, over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is HansolHomeDeco.Co.Ltd'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of the earnings before interest and tax (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 year. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

HansolHomeDeco.Co.Ltd's interest cover and net debt to EBITDA definitely weigh on it, in our esteem. But its conversion of EBIT to free cash flow tells a very different story, and suggests some resilience. Looking at all the angles mentioned above, it does seem to us that HansolHomeDeco.Co.Ltd is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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 4 warning signs for HansolHomeDeco.Co.Ltd (2 make us uncomfortable!) that you should be aware of before investing here.

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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