Stock Analysis

Hyosung Advanced Materials (KRX:298050) Use Of Debt Could Be Considered Risky

KOSE:A298050
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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. We note that Hyosung Advanced Materials Corporation (KRX:298050) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Hyosung Advanced Materials

How Much Debt Does Hyosung Advanced Materials Carry?

You can click the graphic below for the historical numbers, but it shows that Hyosung Advanced Materials had ₩1.60t of debt in December 2020, down from ₩1.75t, one year before. On the flip side, it has ₩51.5b in cash leading to net debt of about ₩1.55t.

debt-equity-history-analysis
KOSE:A298050 Debt to Equity History March 25th 2021

How Strong Is Hyosung Advanced Materials' Balance Sheet?

We can see from the most recent balance sheet that Hyosung Advanced Materials had liabilities of ₩1.57t falling due within a year, and liabilities of ₩420.6b due beyond that. Offsetting these obligations, it had cash of ₩51.5b as well as receivables valued at ₩439.0b due within 12 months. So its liabilities total ₩1.50t more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of ₩1.56t, so it does suggest shareholders should keep an eye on Hyosung Advanced Materials' use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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 0.73 times and a disturbingly high net debt to EBITDA ratio of 7.4 hit our confidence in Hyosung Advanced Materials like a one-two punch to the gut. The debt burden here is substantial. Worse, Hyosung Advanced Materials's EBIT was down 78% over the last year. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Hyosung Advanced Materials can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Considering the last three years, Hyosung Advanced Materials actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

On the face of it, Hyosung Advanced Materials'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. And even its conversion of EBIT to free cash flow fails to inspire much confidence. Taking into account all the aforementioned factors, it looks like Hyosung Advanced Materials has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example Hyosung Advanced Materials has 2 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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About KOSE:A298050

Hs Hyosung Advanced Materials

Manufactures and sells industrial, polyester, nylon, and carpet yarns in South Korea and internationally.

Moderate growth potential low.