Is Kyungdong City Gas (KRX:267290) Using Too Much Debt?

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.' 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. As with many other companies Kyungdong City Gas Co., Ltd (KRX:267290) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Kyungdong City Gas

How Much Debt Does Kyungdong City Gas Carry?

You can click the graphic below for the historical numbers, but it shows that Kyungdong City Gas had ₩12.0b of debt in September 2020, down from ₩12.9b, one year before. However, it does have ₩116.7b in cash offsetting this, leading to net cash of ₩104.8b.

How Healthy Is Kyungdong City Gas's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Kyungdong City Gas had liabilities of ₩146.8b due within 12 months and liabilities of ₩86.4b due beyond that. Offsetting these obligations, it had cash of ₩116.7b as well as receivables valued at ₩97.0b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩19.5b.

Since publicly traded Kyungdong City Gas shares are worth a total of ₩111.7b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Kyungdong City Gas boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Kyungdong City Gas's saving grace is its low debt levels, because its EBIT has tanked 51% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Kyungdong City Gas will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Kyungdong City Gas may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Kyungdong City Gas recorded free cash flow worth 76% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While Kyungdong City Gas does have more liabilities than liquid assets, it also has net cash of ₩104.8b. And it impressed us with free cash flow of -₩19b, being 76% of its EBIT. So we are not troubled with Kyungdong City Gas's debt use. 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 instance, we've identified 2 warning signs for Kyungdong City Gas (1 is significant) you should be aware of.

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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