Health Check: How Prudently Does Chokwang Paint (KRX:004910) Use 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.' 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. We note that Chokwang Paint Co., Ltd. (KRX:004910) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Chokwang Paint

How Much Debt Does Chokwang Paint Carry?

As you can see below, Chokwang Paint had ₩96.2b of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. On the flip side, it has ₩9.02b in cash leading to net debt of about ₩87.1b.

How Strong Is Chokwang Paint's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Chokwang Paint had liabilities of ₩101.9b due within 12 months and liabilities of ₩53.6b due beyond that. On the other hand, it had cash of ₩9.02b and ₩49.2b worth of receivables due within a year. So its liabilities total ₩97.2b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of ₩66.0b, we think shareholders really should watch Chokwang Paint's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Chokwang Paint'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.

In the last year Chokwang Paint had a loss before interest and tax, and actually shrunk its revenue by 2.9%, to ₩200b. That's not what we would hope to see.

Caveat Emptor

Importantly, Chokwang Paint had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost ₩2.4b at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. But on the bright side the company actually produced a statutory profit of ₩6.3b and free cash flow of ₩2.0b. So one might argue that there's still a chance it can get things on the right track. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Chokwang Paint (of which 2 are significant!) you should know about.

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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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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