Does KKO International (EPA:ALKKO) Have A Healthy Balance Sheet?

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, KKO International SA (EPA:ALKKO) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for KKO International

How Much Debt Does KKO International Carry?

The image below, which you can click on for greater detail, shows that KKO International had debt of €8.33m at the end of June 2024, a reduction from €11.1m over a year. However, because it has a cash reserve of €829.3k, its net debt is less, at about €7.50m.

A Look At KKO International's Liabilities

According to the last reported balance sheet, KKO International had liabilities of €4.28m due within 12 months, and liabilities of €9.94m due beyond 12 months. Offsetting these obligations, it had cash of €829.3k as well as receivables valued at €842.5k due within 12 months. So its liabilities total €12.6m more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of €11.8m, we think shareholders really should watch KKO International's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

KKO International has a debt to EBITDA ratio of 4.0 and its EBIT covered its interest expense 2.8 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. One redeeming factor for KKO International is that it turned last year's EBIT loss into a gain of €1.7m, over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is KKO International's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, KKO International burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Mulling over KKO International's attempt at converting EBIT to free cash flow, we're certainly not enthusiastic. Having said that, its ability to grow its EBIT isn't such a worry. We're quite clear that we consider KKO International to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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 example KKO International has 3 warning signs (and 2 which don't sit too well with us) we think you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.