Does KT&G (KRX:033780) Have A Healthy Balance Sheet?

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. We can see that KT&G Corporation (KRX:033780) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.

See our latest analysis for KT&G

How Much Debt Does KT&G Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2023 KT&G had ₩558.9b of debt, an increase on ₩155.6b, over one year. But on the other hand it also has ₩1.67t in cash, leading to a ₩1.11t net cash position.

How Strong Is KT&G's Balance Sheet?

According to the last reported balance sheet, KT&G had liabilities of ₩2.67t due within 12 months, and liabilities of ₩805.1b due beyond 12 months. Offsetting these obligations, it had cash of ₩1.67t as well as receivables valued at ₩1.76t due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.

This state of affairs indicates that KT&G's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the ₩10t company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, KT&G boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that KT&G saw its EBIT decline by 7.9% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine KT&G's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. KT&G 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 most recent three years, KT&G recorded free cash flow worth 62% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

We could understand if investors are concerned about KT&G's liabilities, but we can be reassured by the fact it has has net cash of ₩1.11t. So we don't have any problem with KT&G's use of debt. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check KT&G's dividend history, without delay!

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. 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.