Here's Why KONE Oyj (HEL:KNEBV) Can Manage Its Debt Responsibly

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.' 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. Importantly, KONE Oyj (HEL:KNEBV) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

Our analysis indicates that KNEBV is potentially undervalued!

What Is KONE Oyj's Debt?

The chart below, which you can click on for greater detail, shows that KONE Oyj had €206.6m in debt in June 2022; about the same as the year before. However, its balance sheet shows it holds €1.94b in cash, so it actually has €1.73b net cash.

How Healthy Is KONE Oyj's Balance Sheet?

We can see from the most recent balance sheet that KONE Oyj had liabilities of €5.87b falling due within a year, and liabilities of €861.2m due beyond that. Offsetting these obligations, it had cash of €1.94b as well as receivables valued at €2.70b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €2.09b.

Since publicly traded KONE Oyj shares are worth a very impressive total of €20.7b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, KONE Oyj also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is just as well that KONE Oyj's load is not too heavy, because its EBIT was down 22% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if KONE Oyj 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. While KONE Oyj 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. Happily for any shareholders, KONE Oyj actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While KONE Oyj does have more liabilities than liquid assets, it also has net cash of €1.73b. The cherry on top was that in converted 105% of that EBIT to free cash flow, bringing in €980m. So we are not troubled with KONE Oyj's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for KONE Oyj that you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.