Is Wonik QnC (KOSDAQ:074600) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Wonik QnC Corporation (KOSDAQ:074600) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Wonik QnC

What Is Wonik QnC's Debt?

The image below, which you can click on for greater detail, shows that Wonik QnC had debt of ₩283.0b at the end of September 2020, a reduction from ₩318.0b over a year. However, because it has a cash reserve of ₩50.4b, its net debt is less, at about ₩232.6b.

How Strong Is Wonik QnC's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Wonik QnC had liabilities of ₩170.9b due within 12 months and liabilities of ₩292.9b due beyond that. Offsetting these obligations, it had cash of ₩50.4b as well as receivables valued at ₩77.7b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩335.7b.

This is a mountain of leverage relative to its market capitalization of ₩541.5b. 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). 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 QnC has net debt worth 2.5 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 4.8 times the interest expense. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. It is well worth noting that Wonik QnC's EBIT shot up like bamboo after rain, gaining 97% in the last twelve months. That'll make it easier to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Wonik QnC's ability to maintain a healthy balance sheet going forward. 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 it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Wonik QnC recorded negative free cash flow, in total. 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

Neither Wonik QnC's ability to convert EBIT to free cash flow nor its level of total liabilities gave us confidence in its ability to take on more debt. But the good news is it seems to be able to grow its EBIT with ease. We think that Wonik QnC's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. Be aware that Wonik QnC is showing 2 warning signs in our investment analysis , you should know about...

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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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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