Lion Chemtech (KOSDAQ:171120) Seems To Use Debt Rather Sparingly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Lion Chemtech Co., Ltd. (KOSDAQ:171120) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Lion Chemtech

How Much Debt Does Lion Chemtech Carry?

As you can see below, at the end of December 2020, Lion Chemtech had ₩14.2b of debt, up from ₩11.5b a year ago. Click the image for more detail. However, it does have ₩27.8b in cash offsetting this, leading to net cash of ₩13.7b.

How Strong Is Lion Chemtech's Balance Sheet?

According to the last reported balance sheet, Lion Chemtech had liabilities of ₩23.9b due within 12 months, and liabilities of ₩2.29b due beyond 12 months. Offsetting this, it had ₩27.8b in cash and ₩19.9b in receivables that were due within 12 months. So it can boast ₩21.6b more liquid assets than total liabilities.

This surplus suggests that Lion Chemtech has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Lion Chemtech has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Lion Chemtech grew its EBIT by 37% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Lion Chemtech 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Lion Chemtech 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. Looking at the most recent three years, Lion Chemtech recorded free cash flow of 44% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Lion Chemtech has net cash of ₩13.7b, as well as more liquid assets than liabilities. And we liked the look of last year's 37% year-on-year EBIT growth. So is Lion Chemtech's debt a risk? It doesn't seem so to us. 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. Case in point: We've spotted 2 warning signs for Lion Chemtech you should be aware of, and 1 of them is potentially serious.

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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