KM (KOSDAQ:083550) Seems To Use Debt Rather Sparingly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies KM Corporation (KOSDAQ:083550) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for KM

What Is KM's Net Debt?

The chart below, which you can click on for greater detail, shows that KM had ₩23.9b in debt in September 2020; about the same as the year before. But on the other hand it also has ₩41.5b in cash, leading to a ₩17.5b net cash position.

How Strong Is KM's Balance Sheet?

The latest balance sheet data shows that KM had liabilities of ₩46.8b due within a year, and liabilities of ₩9.42b falling due after that. On the other hand, it had cash of ₩41.5b and ₩24.3b worth of receivables due within a year. So it actually has ₩9.51b more liquid assets than total liabilities.

This surplus suggests that KM has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, KM boasts net cash, so it's fair to say it does not have a heavy debt load!

Even more impressive was the fact that KM grew its EBIT by 491% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since KM will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. KM 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. In the last three years, KM created free cash flow amounting to 13% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case KM has ₩17.5b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 491% over the last year. So is KM's debt a risk? It doesn't seem so to us. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of KM's earnings per share history for free.

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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