We Think Korbank (WSE:KOR) Can Stay On Top Of Its 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.' 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. Importantly, Korbank S.A. (WSE:KOR) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Korbank

What Is Korbank's Net Debt?

As you can see below, at the end of December 2020, Korbank had zł9.49m of debt, up from zł5.30m a year ago. Click the image for more detail. On the flip side, it has zł3.46m in cash leading to net debt of about zł6.03m.

A Look At Korbank's Liabilities

We can see from the most recent balance sheet that Korbank had liabilities of zł11.1m falling due within a year, and liabilities of zł11.7m due beyond that. Offsetting these obligations, it had cash of zł3.46m as well as receivables valued at zł10.4m due within 12 months. So it has liabilities totalling zł8.94m more than its cash and near-term receivables, combined.

Of course, Korbank has a market capitalization of zł46.2m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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.

Korbank's net debt is only 0.66 times its EBITDA. And its EBIT easily covers its interest expense, being 101 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. In addition to that, we're happy to report that Korbank has boosted its EBIT by 40%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Korbank's earnings that will influence how the balance sheet holds up in the future. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Considering the last three years, Korbank actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Our View

Happily, Korbank's impressive interest cover implies it has the upper hand on its debt. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. All these things considered, it appears that Korbank can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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. To that end, you should learn about the 4 warning signs we've spotted with Korbank (including 1 which is concerning) .

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. 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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