Does ktk (TYO:3035) Have A Healthy Balance Sheet?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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, ktk Inc. (TYO:3035) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for ktk

What Is ktk's Net Debt?

The chart below, which you can click on for greater detail, shows that ktk had JP¥1.45b in debt in November 2020; about the same as the year before. However, it does have JP¥2.10b in cash offsetting this, leading to net cash of JP¥657.0m.

A Look At ktk's Liabilities

We can see from the most recent balance sheet that ktk had liabilities of JP¥4.57b falling due within a year, and liabilities of JP¥556.0m due beyond that. Offsetting these obligations, it had cash of JP¥2.10b as well as receivables valued at JP¥2.81b due within 12 months. So it has liabilities totalling JP¥216.0m more than its cash and near-term receivables, combined.

Of course, ktk has a market capitalization of JP¥1.65b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, ktk boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, ktk grew its EBIT by 7.6% in the last year, making that debt load look even more manageable. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since ktk will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. ktk may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, ktk recorded free cash flow worth a fulsome 82% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

While ktk does have more liabilities than liquid assets, it also has net cash of JP¥657.0m. The cherry on top was that in converted 82% of that EBIT to free cash flow, bringing in JP¥505m. So is ktk's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for ktk that you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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This article by Simply Wall St is general in nature. 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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