KD Chem (KOSDAQ:221980) Could Easily Take On More Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, KD Chem Co., Ltd. (KOSDAQ:221980) does carry debt. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. 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, 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.

View our latest analysis for KD Chem

What Is KD Chem's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2020 KD Chem had ₩10.5b of debt, an increase on ₩1.05b, over one year. However, its balance sheet shows it holds ₩28.4b in cash, so it actually has ₩17.9b net cash.

How Healthy Is KD Chem's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that KD Chem had liabilities of ₩12.5b due within 12 months and liabilities of ₩3.06b due beyond that. Offsetting this, it had ₩28.4b in cash and ₩10.7b in receivables that were due within 12 months. So it can boast ₩23.5b more liquid assets than total liabilities.

This surplus liquidity suggests that KD Chem's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is just as strong as misogynists are weak. Simply put, the fact that KD Chem has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, KD Chem's EBIT dived 15%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But it is KD Chem's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While KD Chem has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, KD Chem actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that KD Chem has net cash of ₩17.9b, as well as more liquid assets than liabilities. The cherry on top was that in converted 100% of that EBIT to free cash flow, bringing in ₩8.8b. So we don't think KD Chem's use of debt is risky. 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. For instance, we've identified 2 warning signs for KD Chem that you should be aware of.

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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