Here's Why Lotte Chilsung Beverage (KRX:005300) Is Weighed Down By Its Debt Load

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Lotte Chilsung Beverage Co., Ltd. (KRX:005300) makes use of 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

Check out our latest analysis for Lotte Chilsung Beverage

What Is Lotte Chilsung Beverage's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Lotte Chilsung Beverage had ₩1.60t of debt, an increase on ₩1.45t, over one year. However, it does have ₩238.9b in cash offsetting this, leading to net debt of about ₩1.36t.

A Look At Lotte Chilsung Beverage's Liabilities

According to the last reported balance sheet, Lotte Chilsung Beverage had liabilities of ₩1.52t due within 12 months, and liabilities of ₩1.27t due beyond 12 months. On the other hand, it had cash of ₩238.9b and ₩371.5b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩2.18t.

This deficit casts a shadow over the ₩1.27t company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Lotte Chilsung Beverage would probably need a major re-capitalization if its creditors were to demand repayment.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Lotte Chilsung Beverage has a debt to EBITDA ratio of 3.3 and its EBIT covered its interest expense 3.2 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Investors should also be troubled by the fact that Lotte Chilsung Beverage saw its EBIT drop by 13% over the last twelve months. If that's the way things keep going handling the debt load will be like delivering hot coffees on a pogo stick. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Lotte Chilsung Beverage's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, Lotte Chilsung Beverage recorded free cash flow of 49% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Mulling over Lotte Chilsung Beverage's attempt at staying on top of its total liabilities, we're certainly not enthusiastic. Having said that, its ability to convert EBIT to free cash flow isn't such a worry. Overall, it seems to us that Lotte Chilsung Beverage's balance sheet is really quite a risk to the business. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Lotte Chilsung Beverage 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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.