Is Chunbo (KOSDAQ:278280) A Risky Investment?

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.' 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. Importantly, Chunbo Co., Ltd. (KOSDAQ:278280) does carry debt. But the more important question is: how much risk is that debt creating?

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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Chunbo

What Is Chunbo's Net Debt?

As you can see below, Chunbo had ₩11.6b of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. However, it does have ₩64.8b in cash offsetting this, leading to net cash of ₩53.2b.

How Strong Is Chunbo's Balance Sheet?

The latest balance sheet data shows that Chunbo had liabilities of ₩16.6b due within a year, and liabilities of ₩7.11b falling due after that. Offsetting this, it had ₩64.8b in cash and ₩26.9b in receivables that were due within 12 months. So it can boast ₩68.0b more liquid assets than total liabilities.

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

But the other side of the story is that Chunbo saw its EBIT decline by 7.1% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Chunbo'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. Chunbo 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. Considering the last three years, Chunbo actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Chunbo has net cash of ₩53.2b, as well as more liquid assets than liabilities. So we don't have any problem with Chunbo's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Chunbo .

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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