Lotte Energy Materials (KRX:020150) Takes On Some Risk With Its Use Of Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 note that Lotte Energy Materials Corporation (KRX:020150) 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

Check out our latest analysis for Lotte Energy Materials

How Much Debt Does Lotte Energy Materials Carry?

The image below, which you can click on for greater detail, shows that Lotte Energy Materials had debt of ₩206.2b at the end of December 2023, a reduction from ₩220.5b over a year. But it also has ₩676.6b in cash to offset that, meaning it has ₩470.5b net cash.

How Healthy Is Lotte Energy Materials' Balance Sheet?

We can see from the most recent balance sheet that Lotte Energy Materials had liabilities of ₩332.8b falling due within a year, and liabilities of ₩93.6b due beyond that. On the other hand, it had cash of ₩676.6b and ₩208.0b worth of receivables due within a year. So it actually has ₩458.2b more liquid assets than total liabilities.

This surplus suggests that Lotte Energy Materials is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Lotte Energy Materials has more cash than debt is arguably a good indication that it can manage its debt safely.

Importantly, Lotte Energy Materials's EBIT fell a jaw-dropping 86% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Lotte Energy Materials can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Lotte Energy Materials may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Lotte Energy Materials saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

While it is always sensible to investigate a company's debt, in this case Lotte Energy Materials has ₩470.5b in net cash and a decent-looking balance sheet. So while Lotte Energy Materials does not have a great balance sheet, it's certainly not too bad. While Lotte Energy Materials didn't make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away. Click here to see if its earnings are heading in the right direction, over the medium term.

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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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.