Is KginicisLtd (KOSDAQ:035600) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Kginicis Co.,Ltd (KOSDAQ:035600) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for KginicisLtd

What Is KginicisLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2020 KginicisLtd had ₩214.9b of debt, an increase on ₩181.2b, over one year. However, it does have ₩136.5b in cash offsetting this, leading to net debt of about ₩78.4b.

How Strong Is KginicisLtd's Balance Sheet?

According to the last reported balance sheet, KginicisLtd had liabilities of ₩562.9b due within 12 months, and liabilities of ₩211.9b due beyond 12 months. Offsetting this, it had ₩136.5b in cash and ₩57.2b in receivables that were due within 12 months. So its liabilities total ₩581.1b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of ₩528.4b, we think shareholders really should watch KginicisLtd's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

KginicisLtd's net debt is only 0.50 times its EBITDA. And its EBIT easily covers its interest expense, being 17.3 times the size. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that KginicisLtd has boosted its EBIT by 63%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine KginicisLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, KginicisLtd actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

KginicisLtd's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But the stark truth is that we are concerned by its level of total liabilities. Taking all this data into account, it seems to us that KginicisLtd takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs we've spotted with KginicisLtd .

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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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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