Hancom (KOSDAQ:030520) Seems To Use Debt Rather Sparingly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. We note that Hancom Inc. (KOSDAQ:030520) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Hancom

What Is Hancom's Debt?

As you can see below, Hancom had ₩79.3b of debt at September 2020, down from ₩150.9b a year prior. However, its balance sheet shows it holds ₩155.5b in cash, so it actually has ₩76.2b net cash.

How Strong Is Hancom's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Hancom had liabilities of ₩128.5b due within 12 months and liabilities of ₩143.7b due beyond that. Offsetting these obligations, it had cash of ₩155.5b as well as receivables valued at ₩51.2b due within 12 months. So it has liabilities totalling ₩65.5b more than its cash and near-term receivables, combined.

Of course, Hancom has a market capitalization of ₩450.4b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Hancom also has more cash than debt, so we're pretty confident it can manage its debt safely.

In addition to that, we're happy to report that Hancom has boosted its EBIT by 84%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Hancom can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Hancom has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Hancom recorded free cash flow worth 62% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

Although Hancom's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of ₩76.2b. And it impressed us with its EBIT growth of 84% over the last year. So we don't think Hancom's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Hancom that you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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