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. 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. As with many other companies CJ Logistics Corporation (KRX:000120) makes use of debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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. 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, 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.
See our latest analysis for CJ Logistics
What Is CJ Logistics’s Net Debt?
As you can see below, CJ Logistics had ₩2.65t of debt, at March 2020, which is about the same as the year before. You can click the chart for greater detail. However, it does have ₩508.8b in cash offsetting this, leading to net debt of about ₩2.14t.
A Look At CJ Logistics’s Liabilities
Zooming in on the latest balance sheet data, we can see that CJ Logistics had liabilities of ₩2.81t due within 12 months and liabilities of ₩2.92t due beyond that. Offsetting these obligations, it had cash of ₩508.8b as well as receivables valued at ₩1.52t due within 12 months. So it has liabilities totalling ₩3.70t more than its cash and near-term receivables, combined.
Given this deficit is actually higher than the company’s market capitalization of ₩2.97t, we think shareholders really should watch CJ Logistics’s debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.
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).
CJ Logistics has a debt to EBITDA ratio of 2.7 and its EBIT covered its interest expense 2.5 times. This suggests that while the debt levels are significant, we’d stop short of calling them problematic. On a lighter note, we note that CJ Logistics grew its EBIT by 29% in the last year. If sustained, this growth should make that debt evaporate like a scarce drinking water during an unnaturally hot summer. 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 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.
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 three years, CJ Logistics 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
We’d go so far as to say CJ Logistics’s conversion of EBIT to free cash flow was disappointing. But at least it’s pretty decent at growing its EBIT; that’s encouraging. Overall, we think it’s fair to say that CJ Logistics has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. 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. Consider for instance, the ever-present spectre of investment risk. We’ve identified 3 warning signs with CJ Logistics (at least 1 which is a bit concerning) , and understanding them should be part of your investment process.
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.
Love or hate this article? Concerned about the content? Get in touch with us directly. Alternatively, email [email protected].
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. Thank you for reading.
The easiest way to discover new investment ideas
Save hours of research when discovering your next investment with Simply Wall St. Looking for companies potentially undervalued based on their future cash flows? Or maybe you’re looking for sustainable dividend payers or high growth potential stocks. Customise your search to easily find new investment opportunities that match your investment goals. And the best thing about it? It’s FREE. Click here to learn more.
