KDA Group (CVE:KDA) takes some risk with its use of debt

Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The greatest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We note that KDA Group Inc. (CVE:KDA) has debt on its balance sheet. But does this debt worry shareholders?

When is debt dangerous?

Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. If things go really bad, lenders can take over the business. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business has is to look at its cash and debt together.

See our latest analysis for KDA Group

What is the net debt of the KDA group?

You can click on the graph below for historical figures, but it shows that in January 2022 KDA Group had C$18.3 million in debt, an increase from C$14.6 million , over one year. However, he has C$2.71 million in cash to offset this, resulting in a net debt of approximately C$15.6 million.

TSXV:KDA Debt to Equity May 20, 2022

A look at the liabilities of the KDA group

According to the latest published balance sheet, KDA Group had liabilities of C$16.9 million due within 12 months and liabilities of C$7.75 million due beyond 12 months. In return, he had C$2.71 million in cash and C$5.03 million in debt due within 12 months. It therefore has liabilities totaling C$17.0 million more than its cash and short-term receivables, combined.

Given that this deficit is actually greater than the company’s market capitalization of C$14.8 million, we think shareholders really should be watching KDA Group’s debt levels, like a parent watching their child. riding a bike for the first time. In theory, extremely large dilution would be required if the company were forced to repay its debts by raising capital at the current share price.

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). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).

KDA Group shareholders face the double whammy of a high net debt to EBITDA ratio (30.0) and quite low interest coverage, as EBIT is only 0.042 times the expense of interests. This means that we would consider him to be heavily indebted. Worse still, KDA Group has seen its EBIT drop to 92% in the last 12 months. If earnings continue to follow this trajectory, paying off this debt will be more difficult than convincing us to run a marathon in the rain. There is no doubt that we learn the most about debt from the balance sheet. But you can’t look at debt in total isolation; since KDA Group will need revenue to repay this debt. So, if you want to know more about its earnings, it may be worth checking out this graph of its long-term trend.

Finally, while the taxman may love accounting profits, lenders only accept cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past two years, KDA Group has recorded free cash flow of 67% of its EBIT, which is about normal, given that free cash flow excludes interest and taxes. This cold hard cash allows him to reduce his debt whenever he wants.

Our point of view

At first glance, KDA Group’s interest coverage left us hesitant about the stock, and its EBIT growth rate was no more appealing than the single empty restaurant on the busiest night of the year. But at least it’s decent enough to convert EBIT to free cash flow; it’s encouraging. It should also be noted that KDA Group is in the healthcare business, which is often seen as quite defensive. Overall, it seems to us that KDA Group’s balance sheet is really a risk for the business. We are therefore almost as wary of this stock as a hungry kitten of falling into its owner’s fish pond: once bitten, twice shy, as they say. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. We have identified 3 warning signs with KDA Group, and understanding them should be part of your investment process.

If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-neutral growth stocks right away.

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.

Maria R. Newman