Hankook Steel (KRX:025890) Is Making Moderate 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.' 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. As with many other companies Hankook Steel Co., Ltd. (KRX:025890) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Hankook Steel

What Is Hankook Steel's Net Debt?

As you can see below, at the end of December 2020, Hankook Steel had ₩12.6b of debt, up from ₩11.7b a year ago. Click the image for more detail. However, it does have ₩3.23b in cash offsetting this, leading to net debt of about ₩9.33b.

How Strong Is Hankook Steel's Balance Sheet?

We can see from the most recent balance sheet that Hankook Steel had liabilities of ₩14.5b falling due within a year, and liabilities of ₩1.95b due beyond that. Offsetting these obligations, it had cash of ₩3.23b as well as receivables valued at ₩6.07b due within 12 months. So it has liabilities totalling ₩7.15b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Hankook Steel has a market capitalization of ₩20.8b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. There's no doubt that we learn most about debt from the balance sheet. But it is Hankook Steel'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.

Over 12 months, Hankook Steel made a loss at the EBIT level, and saw its revenue drop to ₩34b, which is a fall of 6.6%. We would much prefer see growth.

Caveat Emptor

Importantly, Hankook Steel had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at ₩128m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled ₩757m in negative free cash flow over the last twelve months. So to be blunt we think it is risky. 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. We've identified 2 warning signs with Hankook Steel (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.

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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