Kumho Petro ChemicalLtd (KRX:011780) Has A Somewhat Strained Balance Sheet

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.' 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 note that Kumho Petro Chemical Co.,Ltd (KRX:011780) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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?

You can click the graphic below for the historical numbers, but it shows that as of September 2024 Kumho Petro ChemicalLtd had ₩889.9b of debt, an increase on ₩772.8b, over one year. On the flip side, it has ₩677.1b in cash leading to net debt of about ₩212.9b.

How Healthy Is Kumho Petro ChemicalLtd's Balance Sheet?

The latest balance sheet data shows that Kumho Petro ChemicalLtd had liabilities of ₩1.45t due within a year, and liabilities of ₩756.3b falling due after that. On the other hand, it had cash of ₩677.1b and ₩852.8b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩672.2b.

While this might seem like a lot, it is not so bad since Kumho Petro ChemicalLtd has a market capitalization of ₩2.28t, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

Kumho Petro ChemicalLtd has a low debt to EBITDA ratio of only 0.38. And remarkably, despite having net debt, it actually received more in interest over the last twelve months than it had to pay. So it's fair to say it can handle debt like a hotshot teppanyaki chef handles cooking. The modesty of its debt load may become crucial for Kumho Petro ChemicalLtd if management cannot prevent a repeat of the 32% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Kumho Petro ChemicalLtd's free cash flow amounted to 25% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

We feel some trepidation about Kumho Petro ChemicalLtd's difficulty EBIT growth rate, but we've got positives to focus on, too. To wit both its interest cover and net debt to EBITDA were encouraging signs. Looking at all the angles mentioned above, it does seem to us that Kumho Petro ChemicalLtd is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. For example, we've discovered 2 warning signs for Kumho Petro ChemicalLtd that you should be aware of before investing here.

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.