Is Korea Gas (KRX:036460) A Risky Investment?

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.' 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. Importantly, Korea Gas Corporation (KRX:036460) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Korea Gas

What Is Korea Gas's Net Debt?

The image below, which you can click on for greater detail, shows that Korea Gas had debt of ₩39t at the end of December 2023, a reduction from ₩43t over a year. However, because it has a cash reserve of ₩823.5b, its net debt is less, at about ₩38t.

A Look At Korea Gas' Liabilities

We can see from the most recent balance sheet that Korea Gas had liabilities of ₩23t falling due within a year, and liabilities of ₩25t due beyond that. On the other hand, it had cash of ₩823.5b and ₩7.04t worth of receivables due within a year. So its liabilities total ₩40t more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the ₩2.12t 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, Korea Gas 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Korea Gas shareholders face the double whammy of a high net debt to EBITDA ratio (11.0), and fairly weak interest coverage, since EBIT is just 1.00 times the interest expense. The debt burden here is substantial. Worse, Korea Gas's EBIT was down 35% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. 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 Korea Gas 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Korea Gas 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

To be frank both Korea Gas's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. And even its interest cover fails to inspire much confidence. We should also note that Gas Utilities industry companies like Korea Gas commonly do use debt without problems. Considering everything we've mentioned above, it's fair to say that Korea Gas is carrying heavy debt load. If you harvest honey without a bee suit, you risk getting stung, so we'd probably stay away from this particular stock. 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. Be aware that Korea Gas is showing 1 warning sign in our investment analysis , you should know about...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.