Is Ko Yo Chemical (Group) (HKG:827) Using Too Much 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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Ko Yo Chemical (Group) Limited (HKG:827) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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

See our latest analysis for Ko Yo Chemical (Group)

What Is Ko Yo Chemical (Group)'s Net Debt?

The chart below, which you can click on for greater detail, shows that Ko Yo Chemical (Group) had CN¥2.17b in debt in December 2020; about the same as the year before. And it doesn't have much cash, so its net debt is about the same.

How Strong Is Ko Yo Chemical (Group)'s Balance Sheet?

We can see from the most recent balance sheet that Ko Yo Chemical (Group) had liabilities of CN¥2.46b falling due within a year, and liabilities of CN¥367.1m due beyond that. On the other hand, it had cash of CN¥14.5m and CN¥60.6m worth of receivables due within a year. So it has liabilities totalling CN¥2.75b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the CN¥400.3m 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. At the end of the day, Ko Yo Chemical (Group) would probably need a major re-capitalization if its creditors were to demand repayment. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Ko Yo Chemical (Group) will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Ko Yo Chemical (Group) reported revenue of CN¥2.1b, which is a gain of 7.5%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Over the last twelve months Ko Yo Chemical (Group) produced an earnings before interest and tax (EBIT) loss. Its EBIT loss was a whopping CN¥58m. Reflecting on this and the significant total liabilities, it's hard to know what to say about the stock because of our intense dis-affinity for it. Sure, the company might have a nice story about how they are going on to a brighter future. But the reality is that it is low on liquid assets relative to liabilities, and it burned through CN¥53m in the last year. So is this a high risk stock? We think so, and we'd avoid it. 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. For instance, we've identified 4 warning signs for Ko Yo Chemical (Group) (2 shouldn't be ignored) you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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