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 Kaonmedia Co, Ltd. (KOSDAQ:078890) does use debt in its business. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. When we examine debt levels, we first consider both cash and debt levels, together.
View our latest analysis for Kaonmedia Co
What Is Kaonmedia Co's Net Debt?
As you can see below, at the end of December 2020, Kaonmedia Co had ₩88.2b of debt, up from ₩80.1b a year ago. Click the image for more detail. However, it also had ₩70.0b in cash, and so its net debt is ₩18.2b.
How Strong Is Kaonmedia Co's Balance Sheet?
The latest balance sheet data shows that Kaonmedia Co had liabilities of ₩150.0b due within a year, and liabilities of ₩22.1b falling due after that. On the other hand, it had cash of ₩70.0b and ₩145.8b worth of receivables due within a year. So it actually has ₩43.6b more liquid assets than total liabilities.
This excess liquidity suggests that Kaonmedia Co is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
While Kaonmedia Co's low debt to EBITDA ratio of 1.3 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 3.2 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Shareholders should be aware that Kaonmedia Co's EBIT was down 68% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But it is Kaonmedia Co's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Kaonmedia Co created free cash flow amounting to 2.4% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.
Our View
Kaonmedia Co's struggle to grow its EBIT had us second guessing its balance sheet strength, but the other data-points we considered were relatively redeeming. In particular, its level of total liabilities was re-invigorating. We think that Kaonmedia Co's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 5 warning signs for Kaonmedia Co you should be aware of, and 1 of them is potentially serious.
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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About KOSDAQ:A078890
KAON Group
Manufactures, develops, and sells digital connectivity devices and services for Pay-TV and broadband industries worldwide.
Good value low.