Is Korporacja KGL (WSE:KGL) A Risky Investment?

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.' 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. We note that Korporacja KGL S.A. (WSE:KGL) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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.

See our latest analysis for Korporacja KGL

What Is Korporacja KGL's Debt?

The image below, which you can click on for greater detail, shows that at September 2021 Korporacja KGL had debt of zł90.8m, up from zł49.8m in one year. However, because it has a cash reserve of zł30.6m, its net debt is less, at about zł60.2m.

A Look At Korporacja KGL's Liabilities

We can see from the most recent balance sheet that Korporacja KGL had liabilities of zł141.2m falling due within a year, and liabilities of zł131.6m due beyond that. Offsetting these obligations, it had cash of zł30.6m as well as receivables valued at zł55.7m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by zł186.5m.

This deficit casts a shadow over the zł73.4m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Korporacja KGL would probably need a major re-capitalization if its creditors were to demand repayment.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Korporacja KGL's net debt is sitting at a very reasonable 2.1 times its EBITDA, while its EBIT covered its interest expense just 4.5 times last year. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Importantly, Korporacja KGL's EBIT fell a jaw-dropping 29% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Korporacja KGL'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. During the last three years, Korporacja KGL produced sturdy free cash flow equating to 59% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

On the face of it, Korporacja KGL'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 on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. We're quite clear that we consider Korporacja KGL to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 5 warning signs we've spotted with Korporacja KGL .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.