Is Korporacja KGL (WSE:KGL) Using Too Much Debt?

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Korporacja KGL S.A. (WSE:KGL) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 Korporacja KGL

What Is Korporacja KGL's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Korporacja KGL had zł61.4m of debt, an increase on zł39.1m, over one year. However, because it has a cash reserve of zł6.14m, its net debt is less, at about zł55.3m.

A Look At Korporacja KGL's Liabilities

Zooming in on the latest balance sheet data, we can see that Korporacja KGL had liabilities of zł100.2m due within 12 months and liabilities of zł115.6m due beyond that. Offsetting these obligations, it had cash of zł6.14m as well as receivables valued at zł32.9m due within 12 months. So its liabilities total zł176.7m more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's zł121.7m market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

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.

Korporacja KGL's net debt of 1.7 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 7.7 times interest expense) certainly does not do anything to dispel this impression. If Korporacja KGL can keep growing EBIT at last year's rate of 19% over the last year, then it will find its debt load easier to manage. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent three years, Korporacja KGL recorded free cash flow of 50% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Korporacja KGL's level of total liabilities was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. In particular, its EBIT growth rate was re-invigorating. When we consider all the factors discussed, it seems to us that Korporacja KGL is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. 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. For example - Korporacja KGL has 3 warning signs we think 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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This article by Simply Wall St is general in nature. 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.
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