Here's Why Hanyang Digitech (KOSDAQ:078350) Has A Meaningful Debt Burden

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. We note that Hanyang Digitech Co., Ltd. (KOSDAQ:078350) 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?

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Hanyang Digitech

What Is Hanyang Digitech's Debt?

As you can see below, Hanyang Digitech had ₩33.5b 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 ₩5.41b, its net debt is less, at about ₩28.1b.

A Look At Hanyang Digitech's Liabilities

According to the last reported balance sheet, Hanyang Digitech had liabilities of ₩74.3b due within 12 months, and liabilities of ₩2.69b due beyond 12 months. Offsetting these obligations, it had cash of ₩5.41b as well as receivables valued at ₩17.6b due within 12 months. So it has liabilities totalling ₩53.9b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of ₩68.5b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

While we wouldn't worry about Hanyang Digitech's net debt to EBITDA ratio of 2.9, we think its super-low interest cover of 1.7 times is a sign of high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. One redeeming factor for Hanyang Digitech is that it turned last year's EBIT loss into a gain of ₩5.1b, over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Hanyang Digitech'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, Hanyang Digitech burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Hanyang Digitech's interest cover left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to grow its EBIT isn't such a worry. Overall, it seems to us that Hanyang Digitech's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. To that end, you should learn about the 4 warning signs we've spotted with Hanyang Digitech (including 2 which are concerning) .

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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