Is Nature and Environment (KOSDAQ:043910) Using Too Much Debt?

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.' 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 Nature and Environment Co., Ltd. (KOSDAQ:043910) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Nature and Environment

What Is Nature and Environment's Debt?

As you can see below, at the end of December 2020, Nature and Environment had ₩18.8b of debt, up from ₩12.4b a year ago. Click the image for more detail. However, it does have ₩17.4b in cash offsetting this, leading to net debt of about ₩1.45b.

How Healthy Is Nature and Environment's Balance Sheet?

We can see from the most recent balance sheet that Nature and Environment had liabilities of ₩28.6b falling due within a year, and liabilities of ₩5.40b due beyond that. Offsetting this, it had ₩17.4b in cash and ₩8.63b in receivables that were due within 12 months. So its liabilities total ₩7.97b more than the combination of its cash and short-term receivables.

Since publicly traded Nature and Environment shares are worth a total of ₩88.7b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Nature and Environment will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Nature and Environment had a loss before interest and tax, and actually shrunk its revenue by 8.0%, to ₩29b. That's not what we would hope to see.

Caveat Emptor

Importantly, Nature and Environment had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost ₩5.6b at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled ₩11b in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Nature and Environment is showing 2 warning signs in our investment analysis , you should know about...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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