These 4 Measures Indicate That KHVATECLtd (KOSDAQ:060720) Is Using Debt Extensively

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 KHVATEC Co.,Ltd. (KOSDAQ:060720) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for KHVATECLtd

How Much Debt Does KHVATECLtd Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 KHVATECLtd had ₩88.1b of debt, an increase on ₩72.7b, over one year. On the flip side, it has ₩44.0b in cash leading to net debt of about ₩44.1b.

How Healthy Is KHVATECLtd's Balance Sheet?

We can see from the most recent balance sheet that KHVATECLtd had liabilities of ₩121.2b falling due within a year, and liabilities of ₩23.9b due beyond that. Offsetting these obligations, it had cash of ₩44.0b as well as receivables valued at ₩36.4b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩64.8b.

Since publicly traded KHVATECLtd shares are worth a total of ₩498.8b, 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.

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.

KHVATECLtd's net debt of 1.8 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 8.0 times interest expense) certainly does not do anything to dispel this impression. Unfortunately, KHVATECLtd's EBIT flopped 18% over the last four quarters. If earnings continue to decline at that rate then handling the debt will be more difficult than taking three children under 5 to a fancy pants restaurant. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if KHVATECLtd can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last two years, KHVATECLtd burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both KHVATECLtd's EBIT growth rate and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that KHVATECLtd's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. While KHVATECLtd didn't make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away. Click here to see if its earnings are heading in the right direction, over the medium term.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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