We Think PaperCorea (KRX:001020) Is Taking Some Risk With Its Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, PaperCorea Inc. (KRX:001020) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for PaperCorea

What Is PaperCorea's Net Debt?

The chart below, which you can click on for greater detail, shows that PaperCorea had ₩417.8b in debt in September 2020; about the same as the year before. On the flip side, it has ₩45.1b in cash leading to net debt of about ₩372.6b.

How Healthy Is PaperCorea's Balance Sheet?

We can see from the most recent balance sheet that PaperCorea had liabilities of ₩222.9b falling due within a year, and liabilities of ₩278.2b due beyond that. Offsetting these obligations, it had cash of ₩45.1b as well as receivables valued at ₩32.3b due within 12 months. So it has liabilities totalling ₩423.7b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the ₩91.4b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, PaperCorea would probably need a major re-capitalization if its creditors were to demand repayment.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 0.75 times and a disturbingly high net debt to EBITDA ratio of 10.8 hit our confidence in PaperCorea like a one-two punch to the gut. The debt burden here is substantial. One redeeming factor for PaperCorea is that it turned last year's EBIT loss into a gain of ₩22b, over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is PaperCorea'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, PaperCorea generated free cash flow amounting to a very robust 98% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

On the face of it, PaperCorea's interest cover left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. We're quite clear that we consider PaperCorea to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. To that end, you should be aware of the 3 warning signs we've spotted with PaperCorea .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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This article by Simply Wall St is general in nature. 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.
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