These 4 metrics indicate Kelsian Group (ASX:KLS) is using debt reasonably well

Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Like many other companies Kelsian Group Limited (ASX:KLS) uses debt. But the real question is whether this debt makes the business risky.

When is debt dangerous?

Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we think about a company’s use of debt, we first look at cash and debt together.

Discover our latest analysis for Kelsian Group

What is Kelsian Group’s debt?

You can click on the graph below for historical figures, but it shows that in December 2021 the Kelsian Group had A$384.2 million in debt, an increase from A$304.6 million , over one year. However, he has A$108.4 million in cash to offset this, resulting in a net debt of around A$275.7 million.

ASX: KLS Debt to Equity History June 25, 2022

A Look at Kelsian Group Liabilities

According to the latest published balance sheet, Kelsian Group had liabilities of A$321.2 million due within 12 months and liabilities of A$573.6 million due beyond 12 months. As compensation for these obligations, it had cash of A$108.4 million as well as receivables valued at A$112.2 million maturing within 12 months. Thus, its liabilities total A$674.1 million more than the combination of its cash and short-term receivables.

Kelsian Group has a market capitalization of A$1.29 billion, so it could very likely raise funds to improve its balance sheet, should the need arise. However, it is always worth taking a close look at your ability to repay debt.

We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). Thus, we consider debt to earnings with and without amortization and depreciation expense.

While Kelsian Group’s debt to EBITDA ratio (2.7) suggests that it uses some debt, its interest coverage is very low at 2.3, suggesting high leverage. It appears that the company is incurring significant depreciation and amortization costs, so perhaps its debt load is heavier than it appears at first glance, since EBITDA is undoubtedly a generous measure benefits. Shareholders should therefore probably be aware that interest charges seem to have had a real impact on the company lately. On the bright side, Kelsian Group increased its EBIT by 34% last year. Like a mother’s loving embrace of a newborn, this kind of growth builds resilience, putting the company in a stronger position to manage its debt. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Kelsian Group can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.

Finally, while the taxman may love accounting profits, lenders only accept cash. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, Kelsian Group has actually produced more free cash flow than EBIT. There’s nothing better than cash coming in to stay in your lenders’ good books.

Our point of view

The good news is that Kelsian Group’s demonstrated ability to convert EBIT into free cash flow delights us like a fluffy puppy does a toddler. But we have to admit that we find that its interest coverage has the opposite effect. Looking at all of the aforementioned factors together, it seems to us that the Kelsian Group can manage its debt quite comfortably. On the plus side, this leverage can increase shareholder returns, but the potential downside is more risk of loss, so it’s worth keeping an eye on the balance sheet. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. Know that Kelsian Group shows 3 warning signs in our investment analysis and 1 of them is significant…

In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeat present.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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