Is KANGWON ENERGY (KOSDAQ:114190) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 note that KANGWON ENERGY Co., Ltd. (KOSDAQ:114190) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for KANGWON ENERGY

What Is KANGWON ENERGY's Debt?

The image below, which you can click on for greater detail, shows that KANGWON ENERGY had debt of ₩42.3b at the end of September 2024, a reduction from ₩45.5b over a year. However, because it has a cash reserve of ₩21.1b, its net debt is less, at about ₩21.2b.

How Healthy Is KANGWON ENERGY's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that KANGWON ENERGY had liabilities of ₩52.7b due within 12 months and liabilities of ₩23.3b due beyond that. On the other hand, it had cash of ₩21.1b and ₩57.5b worth of receivables due within a year. So it can boast ₩2.67b more liquid assets than total liabilities.

Having regard to KANGWON ENERGY's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the ₩217.3b company is short on cash, but still worth keeping an eye on the balance sheet.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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).

KANGWON ENERGY has net debt worth 1.8 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 3.0 times the interest expense. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Notably, KANGWON ENERGY's EBIT launched higher than Elon Musk, gaining a whopping 148% on last year. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since KANGWON ENERGY 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. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, KANGWON ENERGY 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

KANGWON ENERGY's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its EBIT growth rate. When we consider all the factors mentioned above, we do feel a bit cautious about KANGWON ENERGY's use of debt. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for KANGWON ENERGY (of which 1 is a bit unpleasant!) 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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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.