“Credit Checkpoint” is a column 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 numbers 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>

[E-Daily Marketin LEE GEON-EOM Reporter] Despite a rebound in core business profitability in the first half of this year, investors in the corporate bond market are reacting with some caution toward Lotte Construction. Analysts explain that, in contrast to the improvement in earnings, cash generation has weakened somewhat and the debt burden is increasing; therefore, it will take time for the market’s wait-and-see attitude to dissipate solely through improvements in financial stability indicators. Attention is now focused on whether the company can improve its financial health to meet investors’ expectations going forward.

According to the financial investment industry on the 18th, Lotte Construction will conduct a bookbuilding for 50 billion won in corporate bonds on the 19th. Depending on the results, the company is considering increasing the offering size to up to 100 billion won. While the rebound in profitability itself is viewed positively, the prevailing market view is that a successful offering is difficult to guarantee, given the frozen investment sentiment toward construction bonds in general and the company’s fragile financial soundness.

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, as major renovation projects and mixed-use development projects completed sequentially since 2024, coupled with 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% to 172.8 billion won, compared to 40.9 billion won in the same period last year.

The problem is that the projects nearing completion—which boosted profitability—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, a larger net outflow compared to the -455.5 billion won recorded in the same period last year.

This resulted from the accumulation of accounts receivable at sites nearing completion and a corresponding decrease in contract liabilities as construction 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 capital investments—from cash generated through operating activities. A negative FCF indicates that more cash flowed out than was generated through operations, meaning the company had no choice but to rely on external borrowing to cover the funding 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 from the end of the previous year (186.7%).

The market does not view these securities as full-fledged equity. This is because they include a “step-up” clause, whereby the interest rate rises if the securities are not redeemed within the agreement period, making them effectively closer to debt that can be extended beyond maturity. The prevailing market view is that, when the debt nature 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 hybrid capital securities,” but added, “Considering the nature of the debt, the financial burden could increase again if cash generation is not sufficient to support it.”