Is CHEMTRONICS.CO.Ltd (KOSDAQ:089010) Using Too Much Debt?

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that CHEMTRONICS.CO.,Ltd. (KOSDAQ:089010) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for CHEMTRONICS.CO.Ltd

What Is CHEMTRONICS.CO.Ltd's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2020 CHEMTRONICS.CO.Ltd had debt of ₩176.5b, up from ₩128.7b in one year. However, it does have ₩36.9b in cash offsetting this, leading to net debt of about ₩139.6b.

How Healthy Is CHEMTRONICS.CO.Ltd's Balance Sheet?

The latest balance sheet data shows that CHEMTRONICS.CO.Ltd had liabilities of ₩197.7b due within a year, and liabilities of ₩46.3b falling due after that. Offsetting these obligations, it had cash of ₩36.9b as well as receivables valued at ₩54.5b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩152.6b.

This deficit is considerable relative to its market capitalization of ₩253.9b, so it does suggest shareholders should keep an eye on CHEMTRONICS.CO.Ltd's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

CHEMTRONICS.CO.Ltd's debt is 3.2 times its EBITDA, and its EBIT cover its interest expense 4.6 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. Notably, CHEMTRONICS.CO.Ltd's EBIT launched higher than Elon Musk, gaining a whopping 115% on last year. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if CHEMTRONICS.CO.Ltd 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last two years, CHEMTRONICS.CO.Ltd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Neither CHEMTRONICS.CO.Ltd's ability to convert EBIT to free cash flow nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But its EBIT growth rate tells a very different story, and suggests some resilience. When we consider all the factors discussed, it seems to us that CHEMTRONICS.CO.Ltd is taking some risks with its use of debt. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for CHEMTRONICS.CO.Ltd you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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