Is Kumho Petro ChemicalLtd (KRX:011780) Using Too Much Debt?

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 Kumho Petro Chemical Co.,Ltd (KRX:011780) does use debt in its business. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Kumho Petro ChemicalLtd

How Much Debt Does Kumho Petro ChemicalLtd Carry?

As you can see below, Kumho Petro ChemicalLtd had ₩772.8b of debt at September 2023, down from ₩821.2b a year prior. But it also has ₩1.12t in cash to offset that, meaning it has ₩346.1b net cash.

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 ₩1.59t due within 12 months and liabilities of ₩614.9b due beyond that. On the other hand, it had cash of ₩1.12t and ₩825.6b worth of receivables due within a year. So its liabilities total ₩262.5b more than the combination of its cash and short-term receivables.

Since publicly traded Kumho Petro ChemicalLtd shares are worth a total of ₩3.54t, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Kumho Petro ChemicalLtd also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for Kumho Petro ChemicalLtd if management cannot prevent a repeat of the 70% 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. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Kumho Petro ChemicalLtd can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 51% 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

We could understand if investors are concerned about Kumho Petro ChemicalLtd's liabilities, but we can be reassured by the fact it has has net cash of ₩346.1b. So we don't have any problem with Kumho Petro ChemicalLtd's use of 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. Be aware that Kumho Petro ChemicalLtd is showing 2 warning signs in our investment analysis , you should know about...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.