Is Koda (SGX:BJZ) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, Koda Ltd (SGX:BJZ) does carry debt. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Koda

What Is Koda's Debt?

The image below, which you can click on for greater detail, shows that at June 2020 Koda had debt of US$2.71m, up from US$403.0k in one year. But on the other hand it also has US$16.4m in cash, leading to a US$13.7m net cash position.

How Healthy Is Koda's Balance Sheet?

According to the last reported balance sheet, Koda had liabilities of US$12.2m due within 12 months, and liabilities of US$4.96m due beyond 12 months. On the other hand, it had cash of US$16.4m and US$4.73m worth of receivables due within a year. So it actually has US$4.02m more liquid assets than total liabilities.

This short term liquidity is a sign that Koda could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Koda boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Koda if management cannot prevent a repeat of the 28% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Koda will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Koda may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Koda produced sturdy free cash flow equating to 79% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Koda has net cash of US$13.7m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of US$3.5m, being 79% of its EBIT. So we are not troubled with Koda's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Koda , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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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