Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. As with many other companies Kudelski SA (VTX:KUD) makes use of debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
Check out our latest analysis for Kudelski
What Is Kudelski's Net Debt?
As you can see below, Kudelski had US$472.7m of debt at June 2019, down from US$493.3m a year prior. On the flip side, it has US$116.4m in cash leading to net debt of about US$356.3m.
How Healthy Is Kudelski's Balance Sheet?
We can see from the most recent balance sheet that Kudelski had liabilities of US$309.3m falling due within a year, and liabilities of US$506.1m due beyond that. Offsetting these obligations, it had cash of US$116.4m as well as receivables valued at US$282.7m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$416.4m.
When you consider that this deficiency exceeds the company's US$339.4m market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.
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.
Weak interest cover of 1.5 times and a disturbingly high net debt to EBITDA ratio of 7.3 hit our confidence in Kudelski like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. However, the silver lining was that Kudelski achieved a positive EBIT of US$8.9m in the last twelve months, an improvement on the prior year's loss. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Kudelski 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.