Korea Petrochemical Ind (KRX:006650) Seems To Use Debt Quite Sensibly

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.' 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. We can see that Korea Petrochemical Ind. Co., Ltd. (KRX:006650) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. 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. 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 examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Korea Petrochemical Ind

What Is Korea Petrochemical Ind's Debt?

The image below, which you can click on for greater detail, shows that Korea Petrochemical Ind had debt of ₩46.6b at the end of September 2020, a reduction from ₩56.0b over a year. However, it does have ₩211.3b in cash offsetting this, leading to net cash of ₩164.7b.

A Look At Korea Petrochemical Ind's Liabilities

We can see from the most recent balance sheet that Korea Petrochemical Ind had liabilities of ₩85.3b falling due within a year, and liabilities of ₩159.3b due beyond that. On the other hand, it had cash of ₩211.3b and ₩196.7b worth of receivables due within a year. So it actually has ₩163.4b more liquid assets than total liabilities.

This surplus suggests that Korea Petrochemical Ind has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Korea Petrochemical Ind boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that Korea Petrochemical Ind has seen its EBIT plunge 18% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Korea Petrochemical Ind can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Korea Petrochemical Ind 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. During the last three years, Korea Petrochemical Ind produced sturdy free cash flow equating to 73% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to investigate a company's debt, in this case Korea Petrochemical Ind has ₩164.7b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of ₩153b, being 73% of its EBIT. So we are not troubled with Korea Petrochemical Ind's debt use. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Korea Petrochemical Ind you should know about.

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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