Kukdong Oil & ChemicalsLtd (KRX:014530) Seems To Use Debt Quite Sensibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Kukdong Oil & Chemicals Co.,Ltd (KRX:014530) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Kukdong Oil & ChemicalsLtd

What Is Kukdong Oil & ChemicalsLtd's Debt?

As you can see below, at the end of September 2020, Kukdong Oil & ChemicalsLtd had ₩73.5b of debt, up from ₩67.5b a year ago. Click the image for more detail. However, it does have ₩14.9b in cash offsetting this, leading to net debt of about ₩58.6b.

How Strong Is Kukdong Oil & ChemicalsLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Kukdong Oil & ChemicalsLtd had liabilities of ₩80.1b due within 12 months and liabilities of ₩42.4b due beyond that. On the other hand, it had cash of ₩14.9b and ₩51.0b worth of receivables due within a year. So its liabilities total ₩56.6b more than the combination of its cash and short-term receivables.

Kukdong Oil & ChemicalsLtd has a market capitalization of ₩117.0b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Kukdong Oil & ChemicalsLtd's net debt is 2.9 times its EBITDA, which is a significant but still reasonable amount of leverage. But its EBIT was about 11.7 times its interest expense, implying the company isn't really paying a high cost to maintain that level of debt. Even were the low cost to prove unsustainable, that is a good sign. Unfortunately, Kukdong Oil & ChemicalsLtd saw its EBIT slide 8.8% in the last twelve months. If earnings continue on that decline then managing that debt will be difficult like delivering hot soup on a unicycle. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Kukdong Oil & ChemicalsLtd will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Kukdong Oil & ChemicalsLtd generated free cash flow amounting to a very robust 97% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

Both Kukdong Oil & ChemicalsLtd's ability to to convert EBIT to free cash flow and its interest cover gave us comfort that it can handle its debt. On the other hand, its EBIT growth rate makes us a little less comfortable about its debt. When we consider all the elements mentioned above, it seems to us that Kukdong Oil & ChemicalsLtd is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Kukdong Oil & ChemicalsLtd you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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