Is Kogan.com (ASX:KGN) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. We can see that Kogan.com Ltd (ASX:KGN) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Kogan.com

What Is Kogan.com's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2021 Kogan.com had AU$78.7m of debt, an increase on none, over one year. However, it does have AU$91.7m in cash offsetting this, leading to net cash of AU$13.0m.

A Look At Kogan.com's Liabilities

Zooming in on the latest balance sheet data, we can see that Kogan.com had liabilities of AU$163.1m due within 12 months and liabilities of AU$98.2m due beyond that. Offsetting these obligations, it had cash of AU$91.7m as well as receivables valued at AU$7.50m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$162.1m.

Given Kogan.com has a market capitalization of AU$1.12b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Kogan.com boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Kogan.com's saving grace is its low debt levels, because its EBIT has tanked 37% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Kogan.com's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Kogan.com has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Kogan.com saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

While Kogan.com does have more liabilities than liquid assets, it also has net cash of AU$13.0m. So while Kogan.com does not have a great balance sheet, it's certainly not too bad. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 5 warning signs for Kogan.com you should be aware of, and 2 of them shouldn't be ignored.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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.

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