Is KEC Holdings (KRX:006200) Using Too Much Debt?

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.' 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. As with many other companies KEC Holdings Co., Ltd. (KRX:006200) makes use of debt. But is this debt a concern to shareholders?

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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for KEC Holdings

How Much Debt Does KEC Holdings Carry?

As you can see below, KEC Holdings had ₩71.1b of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has ₩77.7b in cash, leading to a ₩6.64b net cash position.

A Look At KEC Holdings's Liabilities

Zooming in on the latest balance sheet data, we can see that KEC Holdings had liabilities of ₩100.3b due within 12 months and liabilities of ₩54.3b due beyond that. Offsetting these obligations, it had cash of ₩77.7b as well as receivables valued at ₩41.4b due within 12 months. So its liabilities total ₩35.5b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of ₩40.6b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, KEC Holdings boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since KEC Holdings 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.

Over 12 months, KEC Holdings made a loss at the EBIT level, and saw its revenue drop to ₩210b, which is a fall of 2.8%. That's not what we would hope to see.

So How Risky Is KEC Holdings?

Although KEC Holdings had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of ₩12b. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. Until we see some positive EBIT, we're a bit cautious of the stock, not least because of the rather modest revenue growth. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Like risks, for instance. Every company has them, and we've spotted 3 warning signs for KEC Holdings (of which 1 is a bit unpleasant!) you should know about.

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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