Is Hanil Networks (KOSDAQ:046110) A Risky Investment?

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.' 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. Importantly, Hanil Networks Co., Ltd. (KOSDAQ:046110) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Hanil Networks

What Is Hanil Networks's Net Debt?

The chart below, which you can click on for greater detail, shows that Hanil Networks had ₩10.0b in debt in September 2020; about the same as the year before. However, it does have ₩21.5b in cash offsetting this, leading to net cash of ₩11.5b.

A Look At Hanil Networks's Liabilities

According to the last reported balance sheet, Hanil Networks had liabilities of ₩36.6b due within 12 months, and liabilities of ₩24.2b due beyond 12 months. Offsetting this, it had ₩21.5b in cash and ₩13.2b in receivables that were due within 12 months. So its liabilities total ₩26.1b more than the combination of its cash and short-term receivables.

Hanil Networks has a market capitalization of ₩60.4b, 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. Despite its noteworthy liabilities, Hanil Networks boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Hanil Networks grew its EBIT by 97% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Hanil Networks 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Hanil Networks may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Hanil Networks actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While Hanil Networks does have more liabilities than liquid assets, it also has net cash of ₩11.5b. And it impressed us with free cash flow of ₩34b, being 190% of its EBIT. So we don't think Hanil Networks's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with Hanil Networks , and understanding them should be part of your investment process.

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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