We Think Komelon (KOSDAQ:049430) Can Manage Its Debt With Ease

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. We can see that Komelon Corporation (KOSDAQ:049430) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. 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. 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.

Check out our latest analysis for Komelon

What Is Komelon's Debt?

As you can see below, Komelon had ₩2.78b of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. But it also has ₩79.8b in cash to offset that, meaning it has ₩77.0b net cash.

How Strong Is Komelon's Balance Sheet?

We can see from the most recent balance sheet that Komelon had liabilities of ₩10.5b falling due within a year, and liabilities of ₩5.47b due beyond that. Offsetting these obligations, it had cash of ₩79.8b as well as receivables valued at ₩15.1b due within 12 months. So it can boast ₩79.0b more liquid assets than total liabilities.

This luscious liquidity implies that Komelon's balance sheet is sturdy like a giant sequoia tree. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Komelon boasts net cash, so it's fair to say it does not have a heavy debt load!

While Komelon doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Komelon 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Komelon 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. During the last three years, Komelon produced sturdy free cash flow equating to 74% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While we empathize with investors who find debt concerning, the bottom line is that Komelon has net cash of ₩77.0b and plenty of liquid assets. And it impressed us with free cash flow of ₩11b, being 74% of its EBIT. So we don't think Komelon's use of debt is risky. 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 - Komelon has 1 warning sign we think 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.

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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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