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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 Kid ASA (OB:KID) makes use of debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Kid
How Much Debt Does Kid Carry?
As you can see below, at the end of June 2019, Kid had kr773.3m of debt, up from kr528.7m a year ago. Click the image for more detail. However, it does have kr151.6m in cash offsetting this, leading to net debt of about kr621.8m.
A Look At Kid's Liabilities
According to the last reported balance sheet, Kid had liabilities of kr796.3m due within 12 months, and liabilities of kr1.42b due beyond 12 months. Offsetting this, it had kr151.6m in cash and kr41.9m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by kr2.02b.
Given this deficit is actually higher than the company's market capitalization of kr1.77b, we think shareholders really should watch Kid's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Kid's net debt of 2.3 times EBITDA suggests graceful use of debt. And the fact that its trailing twelve months of EBIT was 9.2 times its interest expenses harmonizes with that theme. We note that Kid grew its EBIT by 26% 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 ultimately the future profitability of the business will decide if Kid can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.