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. Importantly, Haesung Optics Co., Ltd. (KOSDAQ:076610) does carry debt. 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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. The first step when considering a company’s debt levels is to consider its cash and debt together.
What Is Haesung Optics’s Debt?
You can click the graphic below for the historical numbers, but it shows that Haesung Optics had ₩58.4b of debt in December 2019, down from ₩78.4b, one year before. However, it does have ₩9.97b in cash offsetting this, leading to net debt of about ₩48.4b.
How Strong Is Haesung Optics’s Balance Sheet?
The latest balance sheet data shows that Haesung Optics had liabilities of ₩114.4b due within a year, and liabilities of ₩11.5b falling due after that. On the other hand, it had cash of ₩9.97b and ₩20.6b worth of receivables due within a year. So its liabilities total ₩95.4b more than the combination of its cash and short-term receivables.
The deficiency here weighs heavily on the ₩38.0b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we’d watch its balance sheet closely, without a doubt. After all, Haesung Optics would likely require a major re-capitalisation if it had to pay its creditors today. There’s no doubt that we learn most about debt from the balance sheet. But you can’t view debt in total isolation; since Haesung Optics 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.
Over 12 months, Haesung Optics reported revenue of ₩349b, which is a gain of 71%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.
Even though Haesung Optics managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Indeed, it lost ₩359m at the EBIT level. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. Of course, it may be able to improve its situation with a bit of luck and good execution. But we think that is unlikely, given it is low on liquid assets, and burned through ₩14b in the last year. So we think this stock is risky, like walking through a dirty dog park with a mask on. There’s no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet – far from it. Like risks, for instance. Every company has them, and we’ve spotted 6 warning signs for Haesung Optics (of which 1 makes us a bit uncomfortable!) you should know about.
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.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.
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