Health Check: How Prudently Does TK Chemical (KOSDAQ:104480) Use Debt?

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 can see that TK Chemical Corporation (KOSDAQ:104480) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for TK Chemical

What Is TK Chemical's Debt?

As you can see below, TK Chemical had ₩256.6b of debt at September 2020, down from ₩280.0b a year prior. However, it also had ₩10.3b in cash, and so its net debt is ₩246.3b.

A Look At TK Chemical's Liabilities

Zooming in on the latest balance sheet data, we can see that TK Chemical had liabilities of ₩314.7b due within 12 months and liabilities of ₩95.7b due beyond that. On the other hand, it had cash of ₩10.3b and ₩54.3b worth of receivables due within a year. So its liabilities total ₩345.8b more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's ₩256.5b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. The balance sheet is clearly the area to focus on when you are analysing debt. But it is TK Chemical's earnings that will influence how the balance sheet holds up in the future. 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, TK Chemical made a loss at the EBIT level, and saw its revenue drop to ₩450b, which is a fall of 35%. To be frank that doesn't bode well.

Caveat Emptor

Not only did TK Chemical's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable ₩27b at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. It's fair to say the loss of ₩21b didn't encourage us either; we'd like to see a profit. In the meantime, we consider the stock to be risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for TK Chemical (of which 2 are a bit unpleasant!) you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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