Stock Analysis

Green Cross Holdings (KRX:005250) Use Of Debt Could Be Considered Risky

KOSE:A005250
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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Green Cross Holdings Corporation (KRX:005250) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Green Cross Holdings

What Is Green Cross Holdings's Net Debt?

As you can see below, at the end of September 2020, Green Cross Holdings had ₩1.06t of debt, up from ₩825.0b a year ago. Click the image for more detail. On the flip side, it has ₩287.3b in cash leading to net debt of about ₩770.4b.

debt-equity-history-analysis
KOSE:A005250 Debt to Equity History November 28th 2020

How Healthy Is Green Cross Holdings's Balance Sheet?

The latest balance sheet data shows that Green Cross Holdings had liabilities of ₩1.19t due within a year, and liabilities of ₩507.8b falling due after that. Offsetting these obligations, it had cash of ₩287.3b as well as receivables valued at ₩485.5b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩928.5b.

This deficit isn't so bad because Green Cross Holdings is worth ₩1.65t, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Green Cross Holdings shareholders face the double whammy of a high net debt to EBITDA ratio (7.8), and fairly weak interest coverage, since EBIT is just 2.0 times the interest expense. The debt burden here is substantial. Even worse, Green Cross Holdings saw its EBIT tank 39% 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. There's no doubt that we learn most about debt from the balance sheet. But it is Green Cross Holdings'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Green Cross Holdings saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Green Cross Holdings's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. And even its interest cover fails to inspire much confidence. Taking into account all the aforementioned factors, it looks like Green Cross Holdings has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Green Cross Holdings is showing 5 warning signs in our investment analysis , and 2 of those are a bit concerning...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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