Is Chunbo (KOSDAQ:278280) Using Too Much 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.' 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 Chunbo Co., Ltd. (KOSDAQ:278280) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Chunbo

What Is Chunbo's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Chunbo had ₩25.7b of debt, an increase on ₩11.8b, over one year. However, it does have ₩62.9b in cash offsetting this, leading to net cash of ₩37.2b.

How Strong Is Chunbo's Balance Sheet?

We can see from the most recent balance sheet that Chunbo had liabilities of ₩19.8b falling due within a year, and liabilities of ₩16.3b due beyond that. Offsetting this, it had ₩62.9b in cash and ₩33.1b in receivables that were due within 12 months. So it can boast ₩59.8b 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. Succinctly put, Chunbo boasts net cash, so it's fair to say it does not have a heavy debt load!

And we also note warmly that Chunbo grew its EBIT by 11% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. 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. While Chunbo 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. During the last three years, Chunbo burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

While it is always sensible to investigate a company's debt, in this case Chunbo has ₩37.2b in net cash and a decent-looking balance sheet. On top of that, it increased its EBIT by 11% in the last twelve months. So we are not troubled with Chunbo's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - Chunbo has 1 warning sign we think you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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