Kernel Holding (WSE:KER) Has A Somewhat Strained Balance Sheet

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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, Kernel Holding S.A. (WSE:KER) 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Kernel Holding

What Is Kernel Holding's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2021 Kernel Holding had debt of US$1.65b, up from US$1.18b in one year. On the flip side, it has US$514.0m in cash leading to net debt of about US$1.14b.

A Look At Kernel Holding's Liabilities

According to the last reported balance sheet, Kernel Holding had liabilities of US$1.48b due within 12 months, and liabilities of US$1.13b due beyond 12 months. Offsetting these obligations, it had cash of US$514.0m as well as receivables valued at US$640.5m due within 12 months. So it has liabilities totalling US$1.46b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the US$472.5m 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, Kernel Holding would likely require a major re-capitalisation if it had to pay its creditors today.

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.

While Kernel Holding's low debt to EBITDA ratio of 1.2 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 6.2 times last year does give us pause. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Also positive, Kernel Holding grew its EBIT by 24% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Kernel Holding'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Kernel Holding barely recorded positive free cash flow, in total. Some might say that's a concern, when it comes considering how easily it would be for it to down debt.

Our View

We'd go so far as to say Kernel Holding's level of total liabilities was disappointing. But at least it's pretty decent at growing its EBIT; that's encouraging. Overall, we think it's fair to say that Kernel Holding has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. 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 Kernel Holding has 5 warning signs (and 3 which are a bit unpleasant) we think you should know about.

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.