Here's Why Wonik Holdings (KOSDAQ:030530) Can Manage Its Debt Responsibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Wonik Holdings Co., Ltd (KOSDAQ:030530) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. 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. 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.

See our latest analysis for Wonik Holdings

What Is Wonik Holdings's Net Debt?

As you can see below, Wonik Holdings had ₩184.3b of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of ₩83.5b, its net debt is less, at about ₩100.7b.

How Healthy Is Wonik Holdings's Balance Sheet?

According to the last reported balance sheet, Wonik Holdings had liabilities of ₩218.0b due within 12 months, and liabilities of ₩106.6b due beyond 12 months. Offsetting this, it had ₩83.5b in cash and ₩42.7b in receivables that were due within 12 months. So it has liabilities totalling ₩198.3b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Wonik Holdings is worth ₩492.8b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without 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). 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).

Wonik Holdings's net debt is only 0.94 times its EBITDA. And its EBIT covers its interest expense a whopping 19.5 times over. So we're pretty relaxed about its super-conservative use of debt. And we also note warmly that Wonik Holdings grew its EBIT by 17% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Wonik 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 it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Wonik Holdings created free cash flow amounting to 14% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

When it comes to the balance sheet, the standout positive for Wonik Holdings was the fact that it seems able to cover its interest expense with its EBIT confidently. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit to convert EBIT to free cash flow. When we consider all the elements mentioned above, it seems to us that Wonik Holdings is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider risks, for instance. Every company has them, and we've spotted 3 warning signs for Wonik Holdings you should know about.

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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This article by Simply Wall St is general in nature. 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.
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