Is Hyosung Advanced Materials (KRX:298050) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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, Hyosung Advanced Materials Corporation (KRX:298050) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Hyosung Advanced Materials

How Much Debt Does Hyosung Advanced Materials Carry?

The image below, which you can click on for greater detail, shows that at March 2024 Hyosung Advanced Materials had debt of ₩1.86t, up from ₩1.66t in one year. However, it does have ₩45.8b in cash offsetting this, leading to net debt of about ₩1.81t.

How Healthy Is Hyosung Advanced Materials' Balance Sheet?

According to the last reported balance sheet, Hyosung Advanced Materials had liabilities of ₩1.86t due within 12 months, and liabilities of ₩584.1b due beyond 12 months. Offsetting this, it had ₩45.8b in cash and ₩660.2b in receivables that were due within 12 months. So it has liabilities totalling ₩1.74t more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's ₩1.61t market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). 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).

Hyosung Advanced Materials shareholders face the double whammy of a high net debt to EBITDA ratio (5.2), and fairly weak interest coverage, since EBIT is just 2.0 times the interest expense. This means we'd consider it to have a heavy debt load. Even worse, Hyosung Advanced Materials saw its EBIT tank 40% over the last 12 months. 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. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Hyosung Advanced Materials can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. Over the last three years, Hyosung Advanced Materials reported free cash flow worth 18% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

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 furthermore, its level of total liabilities also fails to instill confidence. Taking into account all the aforementioned factors, it looks like Hyosung Advanced Materials has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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. Case in point: We've spotted 3 warning signs for Hyosung Advanced Materials you should be aware of, and 2 of them are a bit unpleasant.

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.