Is KNOTUSLtd (KOSDAQ:278650) Using Too Much Debt?

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.' 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 KNOTUS Co.,Ltd (KOSDAQ:278650) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for KNOTUSLtd

What Is KNOTUSLtd's Debt?

The chart below, which you can click on for greater detail, shows that KNOTUSLtd had ₩5.90b in debt in September 2020; about the same as the year before. But it also has ₩9.76b in cash to offset that, meaning it has ₩3.86b net cash.

A Look At KNOTUSLtd's Liabilities

According to the last reported balance sheet, KNOTUSLtd had liabilities of ₩13.3b due within 12 months, and liabilities of ₩3.58b due beyond 12 months. Offsetting this, it had ₩9.76b in cash and ₩10.4b in receivables that were due within 12 months. So it can boast ₩3.18b more liquid assets than total liabilities.

This state of affairs indicates that KNOTUSLtd'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 ₩196.2b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, KNOTUSLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that KNOTUSLtd has boosted its EBIT by 38%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is KNOTUSLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. KNOTUSLtd 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 last two years, KNOTUSLtd reported free cash flow worth 11% of its EBIT, which is really quite low. 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 KNOTUSLtd has ₩3.86b in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 38% over the last year. So we don't think KNOTUSLtd's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for KNOTUSLtd that 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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