Here's Why Kolmar Korea (KRX:161890) Is Weighed Down By Its Debt Load

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Kolmar Korea Co., Ltd. (KRX:161890) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Kolmar Korea

How Much Debt Does Kolmar Korea Carry?

You can click the graphic below for the historical numbers, but it shows that Kolmar Korea had ₩1.06t of debt in September 2020, down from ₩1.20t, one year before. However, it also had ₩74.6b in cash, and so its net debt is ₩987.9b.

How Strong Is Kolmar Korea's Balance Sheet?

According to the last reported balance sheet, Kolmar Korea had liabilities of ₩479.3b due within 12 months, and liabilities of ₩975.2b due beyond 12 months. Offsetting these obligations, it had cash of ₩74.6b as well as receivables valued at ₩175.6b due within 12 months. So its liabilities total ₩1.20t more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of ₩1.32t, so it does suggest shareholders should keep an eye on Kolmar Korea's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Kolmar Korea has a rather high debt to EBITDA ratio of 5.6 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 2.8 times, suggesting it can responsibly service its obligations. Even more troubling is the fact that Kolmar Korea actually let its EBIT decrease by 5.3% over the last year. If that earnings trend continues the company will face an uphill battle to pay off its debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Kolmar Korea's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. Over the last three years, Kolmar Korea reported free cash flow worth 5.5% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

We'd go so far as to say Kolmar Korea's net debt to EBITDA was disappointing. And even its level of total liabilities fails to inspire much confidence. We're quite clear that we consider Kolmar Korea to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. Case in point: We've spotted 1 warning sign for Kolmar Korea you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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