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David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Kogan.com Ltd (ASX:KGN) does carry debt. But should shareholders be worried about its use of debt?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Kogan.com's Debt?
As you can see below, at the end of December 2020, Kogan.com had AU$2.71m of debt, up from none a year ago. Click the image for more detail. However, its balance sheet shows it holds AU$79.0m in cash, so it actually has AU$76.2m net cash.
A Look At Kogan.com's Liabilities
We can see from the most recent balance sheet that Kogan.com had liabilities of AU$206.8m falling due within a year, and liabilities of AU$9.64m due beyond that. Offsetting this, it had AU$79.0m in cash and AU$7.45m in receivables that were due within 12 months. So its liabilities total AU$130.1m more than the combination of its cash and short-term receivables.
Given Kogan.com has a market capitalization of AU$1.33b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Kogan.com also has more cash than debt, so we're pretty confident it can manage its debt safely.
Better yet, Kogan.com grew its EBIT by 130% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Kogan.com's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Kogan.com 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. Looking at the most recent three years, Kogan.com recorded free cash flow of 28% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Kogan.com has AU$76.2m in net cash. And it impressed us with its EBIT growth of 130% over the last year. So is Kogan.com's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Kogan.com (at least 1 which is concerning) , 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.
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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