Is Kumho Petro ChemicalLtd (KRX:011780) 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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Kumho Petro Chemical Co.,Ltd (KRX:011780) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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 Kumho Petro ChemicalLtd

What Is Kumho Petro ChemicalLtd's Debt?

As you can see below, at the end of March 2024, Kumho Petro ChemicalLtd had ₩852.6b of debt, up from ₩787.7b a year ago. Click the image for more detail. But on the other hand it also has ₩1.12t in cash, leading to a ₩269.6b net cash position.

How Strong Is Kumho Petro ChemicalLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Kumho Petro ChemicalLtd had liabilities of ₩1.76t due within 12 months and liabilities of ₩671.7b due beyond that. Offsetting these obligations, it had cash of ₩1.12t as well as receivables valued at ₩864.0b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩444.6b.

Of course, Kumho Petro ChemicalLtd has a market capitalization of ₩3.56t, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Kumho Petro ChemicalLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Kumho Petro ChemicalLtd if management cannot prevent a repeat of the 63% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Kumho Petro ChemicalLtd 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, a company can only pay off debt with cold hard cash, not accounting profits. While Kumho Petro ChemicalLtd has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Kumho Petro ChemicalLtd produced sturdy free cash flow equating to 50% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

Although Kumho Petro ChemicalLtd's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of ₩269.6b. So we don't have any problem with Kumho Petro ChemicalLtd's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Kumho Petro ChemicalLtd you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.