Here's Why Chong Kun Dang Holdings (KRX:001630) Has A Meaningful Debt Burden

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Chong Kun Dang Holdings Corp. (KRX:001630) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Chong Kun Dang Holdings

What Is Chong Kun Dang Holdings's Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Chong Kun Dang Holdings had debt of ₩216.6b, up from ₩150.9b in one year. On the flip side, it has ₩107.5b in cash leading to net debt of about ₩109.1b.

How Strong Is Chong Kun Dang Holdings' Balance Sheet?

We can see from the most recent balance sheet that Chong Kun Dang Holdings had liabilities of ₩280.4b falling due within a year, and liabilities of ₩137.8b due beyond that. Offsetting these obligations, it had cash of ₩107.5b as well as receivables valued at ₩117.4b due within 12 months. So it has liabilities totalling ₩193.2b more than its cash and near-term receivables, combined.

Chong Kun Dang Holdings has a market capitalization of ₩533.6b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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.

Chong Kun Dang Holdings has a low net debt to EBITDA ratio of only 0.91. And its EBIT easily covers its interest expense, being 40.1 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Fortunately, Chong Kun Dang Holdings grew its EBIT by 3.2% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Chong Kun Dang Holdings's ability to maintain a healthy balance sheet going forward. 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Chong Kun Dang Holdings saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Chong Kun Dang Holdings's conversion of EBIT to free cash flow and level of total liabilities definitely weigh on it, in our esteem. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. We think that Chong Kun Dang Holdings's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. 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. For example, we've discovered 2 warning signs for Chong Kun Dang Holdings (1 makes us a bit uncomfortable!) that you should be aware of before investing here.

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. 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.
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