Kycom Holdings (TYO:9685) Seems To Use Debt Quite Sensibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Kycom Holdings Co., Ltd. (TYO:9685) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Kycom Holdings

How Much Debt Does Kycom Holdings Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Kycom Holdings had debt of JP¥2.17b, up from JP¥1.23b in one year. However, it does have JP¥1.22b in cash offsetting this, leading to net debt of about JP¥951.0m.

A Look At Kycom Holdings's Liabilities

We can see from the most recent balance sheet that Kycom Holdings had liabilities of JP¥1.27b falling due within a year, and liabilities of JP¥1.88b due beyond that. Offsetting these obligations, it had cash of JP¥1.22b as well as receivables valued at JP¥606.0m due within 12 months. So its liabilities total JP¥1.32b more than the combination of its cash and short-term receivables.

Kycom Holdings has a market capitalization of JP¥4.42b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Kycom Holdings's net debt to EBITDA ratio of about 2.0 suggests only moderate use of debt. And its commanding EBIT of 1k times its interest expense, implies the debt load is as light as a peacock feather. If Kycom Holdings can keep growing EBIT at last year's rate of 14% over the last year, then it will find its debt load easier to manage. When analysing debt levels, the balance sheet is the obvious place to start. But it is Kycom Holdings'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Considering the last three years, Kycom Holdings actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

When it comes to the balance sheet, the standout positive for Kycom Holdings was the fact that it seems able to cover its interest expense with its EBIT confidently. However, our other observations weren't so heartening. In particular, conversion of EBIT to free cash flow gives us cold feet. Looking at all this data makes us feel a little cautious about Kycom Holdings's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. 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. Take risks, for example - Kycom Holdings has 6 warning signs (and 1 which is a bit concerning) we think you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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