Here's Why Korean AirlinesLtd (KRX:003490) Has A Meaningful Debt Burden

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. We can see that Korean Airlines Co.,Ltd. (KRX:003490) does use debt in its business. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Korean AirlinesLtd

How Much Debt Does Korean AirlinesLtd Carry?

As you can see below, at the end of March 2024, Korean AirlinesLtd had ₩6.89t of debt, up from ₩6.44t a year ago. Click the image for more detail. On the flip side, it has ₩6.49t in cash leading to net debt of about ₩404.7b.

How Strong Is Korean AirlinesLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Korean AirlinesLtd had liabilities of ₩11t due within 12 months and liabilities of ₩11t due beyond that. On the other hand, it had cash of ₩6.49t and ₩1.30t worth of receivables due within a year. So it has liabilities totalling ₩14t more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the ₩7.89t company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Korean AirlinesLtd would likely require a major re-capitalisation if it had to pay its creditors today.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

With net debt sitting at just 0.11 times EBITDA, Korean AirlinesLtd is arguably pretty conservatively geared. And this view is supported by the solid interest coverage, with EBIT coming in at 8.0 times the interest expense over the last year. In fact Korean AirlinesLtd's saving grace is its low debt levels, because its EBIT has tanked 28% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Korean AirlinesLtd'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Korean AirlinesLtd 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

On the face of it, Korean AirlinesLtd's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Once we consider all the factors above, together, it seems to us that Korean AirlinesLtd's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. For example, we've discovered 2 warning signs for Korean AirlinesLtd (1 doesn't sit too well with us!) that you should be aware of before investing here.

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com