Is Chinyang Poly UrethaneLtd (KRX:010640) A Risky Investment?

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 the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Chinyang Poly UrethaneLtd

What Is Chinyang Poly UrethaneLtd's Debt?

As you can see below, Chinyang Poly UrethaneLtd had ₩8.05b of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of ₩417.3m, its net debt is less, at about ₩7.63b.

How Strong Is Chinyang Poly UrethaneLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Chinyang Poly UrethaneLtd had liabilities of ₩8.19b due within 12 months and liabilities of ₩9.69b due beyond that. Offsetting these obligations, it had cash of ₩417.3m as well as receivables valued at ₩6.46b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩11.0b.

Chinyang Poly UrethaneLtd has a market capitalization of ₩37.4b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Chinyang Poly UrethaneLtd's net debt to EBITDA ratio of about 1.9 suggests only moderate use of debt. And its commanding EBIT of 13.7 times its interest expense, implies the debt load is as light as a peacock feather. Importantly, Chinyang Poly UrethaneLtd's EBIT fell a jaw-dropping 28% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Chinyang Poly UrethaneLtd'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Chinyang Poly UrethaneLtd saw substantial negative free cash flow, in total. 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.

Our View

On the face of it, Chinyang Poly UrethaneLtd's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that Chinyang Poly UrethaneLtd's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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 instance, we've identified 2 warning signs for Chinyang Poly UrethaneLtd that 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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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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