“Credit Checkpoint” is a section that assesses the credit rating risks of companies preparing to issue corporate bonds by examining their financial structure and cash flow. We evaluate a company’s short- and medium-term financial stability by focusing not only on the figures in its financial statements but also on the quality and sustainability of its cash flow. We highlight key financial indicators and potential risk factors to help corporate bond investors and market participants assess a company’s creditworthiness from a more comprehensive perspective. <Editor’s Note>

[Edaily Marketin Reporter LEE GEON-EOM ] Despite a rebound in core business profitability in the first half of this year, Lotte Construction is facing assessments that this is insufficient to elicit a favorable response from corporate bond investors. Analysts explain that with cash generation declining and debt burdens rising—in contrast to the improvement in earnings—it will be difficult to shift the market’s deep-seated wait-and-see attitude based solely on superficial improvements in financial stability. In particular, since the improvement in the debt-to-equity ratio stems more from accounting effects resulting from the issuance of hybrid capital securities rather than actual business performance, it is expected to be difficult to meet investors’ increasingly stringent standards.

According to the financial investment industry on the 18th, Lotte Construction will conduct a bookbuilding process for 50 billion won worth of corporate bonds on the 19th. Depending on the results, the company is considering increasing the issuance amount to as much as 100 billion won. While the rebound in profitability itself is viewed positively, the prevailing market view is that a successful issuance is far from guaranteed, given the frozen investment sentiment toward construction bonds in general and the company’s fragile financial health.

Lotte Construction’s consolidated revenue for the first half of this year was 3.2804 trillion won, a 12.5% decrease compared to the same period last year. This was largely due to a 9.7% year-over-year decline in revenue from the construction division, driven by the sequential completion of large-scale renovation and mixed-use development projects since 2024 and a significant drop in supply volume last year.

Although revenue declined, profitability actually rebounded. As high-cost projects continued to be completed, the cost of sales ratio fell to 90.2%—a 4.3 percentage point decrease from 94.5% in the same period last year—and the recognition of large-scale bad debt provisions has come to an end. Driven by these factors, operating profit rose 322.9% year-over-year to 172.8 billion won, up from 40.9 billion won in the same period last year.

The issue, however, is that the projects nearing completion—which drove the profitability boost—actually had a negative impact on cash flow. Lotte Construction’s cash flow from operating activities for the first half of the year was negative (-) 685.3 billion won, marking a larger net outflow compared to the -455.5 billion won recorded in the same period last year.

This resulted from a buildup of accounts receivable at sites nearing completion and a corresponding decrease in contract liabilities as work progressed. With 865.9 billion won tied up in working capital alone, free cash flow (FCF)—which accounts for capital expenditures—recorded a negative (-) 690.6 billion won.

FCF represents the actual available cash remaining after deducting capital expenditures—such as facility investments—from cash generated through operating activities. A negative FCF indicates that cash outflows exceeded cash inflows from operations, meaning the company had no choice but to rely on external borrowing to cover the shortfall. In fact, Lotte Construction’s total debt as of the end of June this year stood at 3.2317 trillion won, a 21.2% increase from 2.6670 trillion won at the end of the previous year. Net debt also rose 7.4% to 2.0573 trillion won compared to the end of the previous year (1.9154 trillion won).

Apparently mindful of the growing debt burden, Lotte Construction issued 30-year hybrid capital securities totaling 700 billion won—350 billion won in each of two tranches in December of last year and January of this year. Hotel Lotte provided a capital replenishment agreement worth 400 billion won, while Lotte Corporation provided one worth 300 billion won. As these amounts were classified as equity on the balance sheet, the debt-to-equity ratio fell to 162.8%, a decrease of 23.9 percentage points compared to the end of the previous year (186.7%).

The market does not view these securities as full-fledged capital. This is because they include a “step-up” clause, whereby the interest rate rises if they are not repaid within the agreed period, making them effectively similar to debt that can be extended to maturity. The prevailing view in the market is that, when the nature of the debt is taken into account, the actual debt burden borne by Lotte Construction is far heavier than the apparent decline in the debt-to-equity ratio suggests.

Park Chan-bo, a senior researcher at Korea Ratings, stated in a report, “Financial indicators have improved in the short term due to the new capital securities,” but added, “Considering the nature of the debt, the financial burden could increase again if it is not supported by cash generation.”