We Think KLON Spólka Akcyjna (WSE:KLN) Can Stay On Top Of Its Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies KLON Spólka Akcyjna (WSE:KLN) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for KLON Spólka Akcyjna

What Is KLON Spólka Akcyjna's Debt?

You can click the graphic below for the historical numbers, but it shows that KLON Spólka Akcyjna had zł11.5m of debt in March 2021, down from zł13.4m, one year before. However, it also had zł967.8k in cash, and so its net debt is zł10.5m.

A Look At KLON Spólka Akcyjna's Liabilities

We can see from the most recent balance sheet that KLON Spólka Akcyjna had liabilities of zł6.88m falling due within a year, and liabilities of zł13.0m due beyond that. Offsetting these obligations, it had cash of zł967.8k as well as receivables valued at zł2.52m due within 12 months. So its liabilities total zł16.4m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since KLON Spólka Akcyjna has a market capitalization of zł42.1m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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 we wouldn't worry about KLON Spólka Akcyjna's net debt to EBITDA ratio of 3.4, we think its super-low interest cover of 1.3 times is a sign of high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Looking on the bright side, KLON Spólka Akcyjna boosted its EBIT by a silky 49% in the last year. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since KLON Spólka Akcyjna will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, KLON Spólka Akcyjna recorded free cash flow worth 79% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

The good news is that KLON Spólka Akcyjna's demonstrated ability to grow its EBIT delights us like a fluffy puppy does a toddler. But we must concede we find its interest cover has the opposite effect. Looking at all the aforementioned factors together, it strikes us that KLON Spólka Akcyjna can handle its debt fairly comfortably. Of course, while this leverage can enhance returns on equity, it does bring more risk, so it's worth keeping an eye on this one. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that KLON Spólka Akcyjna is showing 5 warning signs in our investment analysis , and 2 of those are a bit concerning...

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. 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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