We Think Hana Materials (KOSDAQ:166090) Can Stay On Top Of Its Debt

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.' 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. Importantly, Hana Materials Inc. (KOSDAQ:166090) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Hana Materials

What Is Hana Materials's Debt?

You can click the graphic below for the historical numbers, but it shows that Hana Materials had ₩126.2b of debt in September 2020, down from ₩139.8b, one year before. However, because it has a cash reserve of ₩29.0b, its net debt is less, at about ₩97.2b.

A Look At Hana Materials's Liabilities

The latest balance sheet data shows that Hana Materials had liabilities of ₩74.5b due within a year, and liabilities of ₩87.0b falling due after that. Offsetting these obligations, it had cash of ₩29.0b as well as receivables valued at ₩10.9b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩121.5b.

Hana Materials has a market capitalization of ₩486.8b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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

Hana Materials has a low net debt to EBITDA ratio of only 1.5. And its EBIT easily covers its interest expense, being 16.0 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Fortunately, Hana Materials grew its EBIT by 9.8% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Hana Materials will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

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. During the last three years, Hana Materials 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

Hana Materials's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its interest cover. When we consider all the factors mentioned above, we do feel a bit cautious about Hana Materials's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. To that end, you should be aware of the 1 warning sign we've spotted with Hana Materials .

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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