Chinyang Poly UrethaneLtd (KRX:010640) Seems To Use Debt Quite Sensibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 can see that Chinyang Poly Urethane Co.,Ltd (KRX:010640) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Chinyang Poly UrethaneLtd

How Much Debt Does Chinyang Poly UrethaneLtd Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Chinyang Poly UrethaneLtd had ₩16.6b of debt, an increase on ₩10.2b, over one year. On the flip side, it has ₩1.85b in cash leading to net debt of about ₩14.7b.

A Look At Chinyang Poly UrethaneLtd's Liabilities

We can see from the most recent balance sheet that Chinyang Poly UrethaneLtd had liabilities of ₩8.23b falling due within a year, and liabilities of ₩17.3b due beyond that. On the other hand, it had cash of ₩1.85b and ₩6.92b worth of receivables due within a year. So its liabilities total ₩16.7b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Chinyang Poly UrethaneLtd has a market capitalization of ₩75.0b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

We'd say that Chinyang Poly UrethaneLtd's moderate net debt to EBITDA ratio ( being 2.1), indicates prudence when it comes to debt. And its strong interest cover of 46.2 times, makes us even more comfortable. Importantly, Chinyang Poly UrethaneLtd grew its EBIT by 43% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Chinyang Poly UrethaneLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Chinyang Poly UrethaneLtd recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

Both Chinyang Poly UrethaneLtd's ability to to cover its interest expense with its EBIT and its EBIT growth rate gave us comfort that it can handle its debt. In contrast, our confidence was undermined by its apparent struggle to convert EBIT to free cash flow. When we consider all the elements mentioned above, it seems to us that Chinyang Poly UrethaneLtd is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Chinyang Poly UrethaneLtd is showing 5 warning signs in our investment analysis , and 1 of those is significant...

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.