Huchems Fine Chemical (KRX:069260) Seems To Use Debt Quite Sensibly

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. Importantly, Huchems Fine Chemical Corporation (KRX:069260) does carry debt. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Huchems Fine Chemical

What Is Huchems Fine Chemical's Debt?

As you can see below, Huchems Fine Chemical had ₩54.0b of debt at September 2020, down from ₩96.6b a year prior. However, it does have ₩275.9b in cash offsetting this, leading to net cash of ₩222.0b.

How Strong Is Huchems Fine Chemical's Balance Sheet?

We can see from the most recent balance sheet that Huchems Fine Chemical had liabilities of ₩100.3b falling due within a year, and liabilities of ₩90.2b due beyond that. Offsetting this, it had ₩275.9b in cash and ₩86.8b in receivables that were due within 12 months. So it actually has ₩172.3b more liquid assets than total liabilities.

This surplus suggests that Huchems Fine Chemical is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Huchems Fine Chemical has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Huchems Fine Chemical's saving grace is its low debt levels, because its EBIT has tanked 25% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Huchems Fine Chemical's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Huchems Fine Chemical 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. Over the most recent three years, Huchems Fine Chemical recorded free cash flow worth 71% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to investigate a company's debt, in this case Huchems Fine Chemical has ₩222.0b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of ₩61b, being 71% of its EBIT. So we are not troubled with Huchems Fine Chemical's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Huchems Fine Chemical that you should be aware of before investing here.

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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