CJ Logistics (KRX:000120) Takes On Some Risk With Its Use Of Debt

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 note that CJ Logistics Corporation (KRX:000120) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for CJ Logistics

What Is CJ Logistics's Net Debt?

The image below, which you can click on for greater detail, shows that CJ Logistics had debt of ₩2.12t at the end of March 2024, a reduction from ₩2.46t over a year. However, because it has a cash reserve of ₩530.8b, its net debt is less, at about ₩1.59t.

How Healthy Is CJ Logistics' Balance Sheet?

We can see from the most recent balance sheet that CJ Logistics had liabilities of ₩3.00t falling due within a year, and liabilities of ₩2.59t due beyond that. Offsetting these obligations, it had cash of ₩530.8b as well as receivables valued at ₩1.51t due within 12 months. So its liabilities total ₩3.54t more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the ₩1.91t company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, CJ Logistics would probably need a major re-capitalization if its creditors were to demand repayment.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Looking at its net debt to EBITDA of 1.5 and interest cover of 3.7 times, it seems to us that CJ Logistics is probably using debt in a pretty reasonable way. So we'd recommend keeping a close eye on the impact financing costs are having on the business. If CJ Logistics can keep growing EBIT at last year's rate of 15% over the last year, then it will find its debt load easier to manage. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if CJ Logistics 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. During the last three years, CJ Logistics generated free cash flow amounting to a very robust 83% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

CJ Logistics's level of total liabilities and interest cover definitely weigh on it, in our esteem. But the good news is it seems to be able to convert EBIT to free cash flow with ease. When we consider all the factors discussed, it seems to us that CJ Logistics is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. 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 1 warning sign for CJ Logistics 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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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.

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