[Beginner's Guide] Airline Stocks Unable to Soar Despite Reopening... What Does Capital Erosion Mean?

[Asia Economy Reporter Kwon Jae-hee] The stock prices of domestic low-cost carriers (LCCs) are struggling. It was expected that stock prices would gain momentum with the reopening, but this time 'capital erosion' has surfaced. Since COVID-19, companies have survived through rights offerings and other means, but the ongoing high exchange rates and high oil prices have intensified financial pressure. Capital erosion determines the survival of a company. Let's find out what capital erosion is and what it means.

Air Busan Falls into Complete Capital Erosion

Air Busan has raised over 400 billion KRW through three rounds of rights offerings. Although it survived the COVID-19 situation through these rights offerings, the recent high exchange rates and high oil prices have increased the burden of foreign currency translation losses. Air Busan has already recorded a total capital of -20.3 billion KRW on a separate basis in the first half of this year, falling into a state of complete capital erosion.

The situation is similar for other low-cost carriers. Jeju Air, T'way Air, and others have also survived through several rounds of rights offerings, and the scale of foreign currency translation losses due to high exchange rates and high oil prices is increasing.

The Meaning of Capital Erosion

To understand the meaning of capital erosion, we first need to know total capital. When running a business, it is not operated with 100% equity capital. For example, suppose a company called A was established with 100 million KRW in capital and borrowed 100 million KRW from a bank. After operating for a year, suppose it made a profit of 30 million KRW. If 10 million KRW of the profit is paid out as dividends to shareholders, 20 million KRW remains as profit. Returning to the beginning, there is 100 million KRW in capital, 100 million KRW in debt, and 20 million KRW in profit. Excluding debt, the total capital is 120 million KRW.

In a normal company, total capital should continue to increase. However, the opposite can also happen. Total capital decreases continuously and becomes less than the capital stock. This is called 'capital erosion.'

Using the previous example, capital erosion is like this: a company that started with 100 million KRW in capital and 100 million KRW in debt suffers a loss of 50 million KRW after one year, so total capital becomes 50 million KRW. When total capital becomes less than the capital stock due to losses, it is said to be 'in capital erosion.'

If a loss of 60 million KRW occurs the following year, total capital (50 million KRW) becomes negative. This is called 'complete capital erosion.'

Why is Capital Erosion Dangerous?

Complete capital erosion is a cause for delisting on the domestic stock market. In fact, Hanjin Heavy Industries was suspended from trading in 2019 due to complete capital erosion and received a delisting warning. Due to deteriorating performance and increased financial risk, Hanjin Heavy Industries' stock price, which was over 40,000 KRW in 2018, fell to the 4,000 KRW range in 2019.

Stock investors must be cautious of capital erosion. If a company’s total capital is less than its capital stock, it should be excluded from the investment list. Although some companies recover from capital erosion by returning to profitability, many cases lead to delisting, so special caution is necessary.

Editor's Note[Beginner's Guide to Stocks] is a smart investment guide for 'Joorini' (stock + beginner). We will kindly and easily explain stock stories unfamiliar to beginners.

This content was produced with the assistance of AI translation services.