Kumho Petro ChemicalLtd (KRX:011780) Takes On Some Risk With Its Use Of 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 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.

Our free stock report includes 2 warning signs investors should be aware of before investing in Kumho Petro ChemicalLtd. Read for free now.

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. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Kumho Petro ChemicalLtd Carry?

The image below, which you can click on for greater detail, shows that at December 2024 Kumho Petro ChemicalLtd had debt of ₩882.6b, up from ₩821.9b in one year. However, because it has a cash reserve of ₩780.3b, its net debt is less, at about ₩102.3b.

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 ₩1.53t due within 12 months and liabilities of ₩763.5b due beyond that. On the other hand, it had cash of ₩780.3b and ₩888.7b worth of receivables due within a year. So its liabilities total ₩629.0b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Kumho Petro ChemicalLtd has a market capitalization of ₩2.83t, 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.

View our latest analysis for Kumho Petro ChemicalLtd

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Kumho Petro ChemicalLtd has net debt of just 0.19 times EBITDA, suggesting it could ramp leverage without breaking a sweat. 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. In fact Kumho Petro ChemicalLtd's saving grace is its low debt levels, because its EBIT has tanked 25% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 basically broke even on a free cash flow basis. While many companies do operate at break-even, we prefer see substantial free cash flow, especially if a it already has dead.

Our View

While Kumho Petro ChemicalLtd's EBIT growth rate has us nervous. To wit both its interest cover and net debt to EBITDA were encouraging signs. When we consider all the factors discussed, it seems to us that Kumho Petro ChemicalLtd is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. 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 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.