Korean AirlinesLtd (KRX:003490) Seems To Use Debt Quite Sensibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Korean Airlines Co.,Ltd. (KRX:003490) makes use of debt. But should shareholders be worried about its use of debt?

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Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Korean AirlinesLtd Carry?

As you can see below, at the end of December 2024, Korean AirlinesLtd had ₩8.50t of debt, up from ₩6.51t a year ago. Click the image for more detail. On the flip side, it has ₩6.73t in cash leading to net debt of about ₩1.77t.

How Strong Is Korean AirlinesLtd's Balance Sheet?

The latest balance sheet data shows that Korean AirlinesLtd had liabilities of ₩17t due within a year, and liabilities of ₩19t falling due after that. Offsetting these obligations, it had cash of ₩6.73t as well as receivables valued at ₩1.63t due within 12 months. So it has liabilities totalling ₩28t more than its cash and near-term receivables, combined.

This deficit casts a shadow over the ₩7.96t company, like a colossus towering over mere mortals. 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.

View our latest analysis for Korean AirlinesLtd

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.

With net debt sitting at just 0.45 times EBITDA, Korean AirlinesLtd is arguably pretty conservatively geared. And it boasts interest cover of 9.2 times, which is more than adequate. And we also note warmly that Korean AirlinesLtd grew its EBIT by 17% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. 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, 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. Happily for any shareholders, Korean AirlinesLtd actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Korean AirlinesLtd's level of total liabilities was a real negative on this analysis, although the other factors we considered were considerably better. There's no doubt that its ability to to convert EBIT to free cash flow is pretty flash. Looking at all this data makes us feel a little cautious about Korean AirlinesLtd's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Korean AirlinesLtd you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.