Is KMH Hitech (KOSDAQ:052900) A Risky Investment?

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. Importantly, KMH Hitech Co., Ltd. (KOSDAQ:052900) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

Check out our latest analysis for KMH Hitech

How Much Debt Does KMH Hitech Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 KMH Hitech had ₩4.43b of debt, an increase on ₩2.43b, over one year. But it also has ₩5.00b in cash to offset that, meaning it has ₩570.8m net cash.

How Healthy Is KMH Hitech's Balance Sheet?

According to the last reported balance sheet, KMH Hitech had liabilities of ₩17.1b due within 12 months, and liabilities of ₩6.91b due beyond 12 months. Offsetting this, it had ₩5.00b in cash and ₩12.8b in receivables that were due within 12 months. So its liabilities total ₩6.21b more than the combination of its cash and short-term receivables.

Since publicly traded KMH Hitech shares are worth a total of ₩90.6b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, KMH Hitech also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, KMH Hitech grew its EBIT by 88% over the last twelve months, and that growth will make it easier to handle its debt. 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 KMH Hitech 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. KMH Hitech 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. During the last three years, KMH Hitech burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

We could understand if investors are concerned about KMH Hitech's liabilities, but we can be reassured by the fact it has has net cash of ₩570.8m. And we liked the look of last year's 88% year-on-year EBIT growth. So we are not troubled with KMH Hitech's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for KMH Hitech 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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