Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, KOAS Co., Ltd. (KRX:071950) does carry debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does KOAS Carry?
The chart below, which you can click on for greater detail, shows that KOAS had ₩23.2b in debt in September 2020; about the same as the year before. On the flip side, it has ₩1.05b in cash leading to net debt of about ₩22.1b.
How Healthy Is KOAS' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that KOAS had liabilities of ₩42.4b due within 12 months and liabilities of ₩5.24b due beyond that. On the other hand, it had cash of ₩1.05b and ₩6.39b worth of receivables due within a year. So its liabilities total ₩40.2b more than the combination of its cash and short-term receivables.
Given this deficit is actually higher than the company's market capitalization of ₩35.7b, we think shareholders really should watch KOAS's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since KOAS 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 KOAS had a loss before interest and tax, and actually shrunk its revenue by 10%, to ₩103b. That's not what we would hope to see.
While KOAS's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost ₩1.3b at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through ₩1.7b in negative free cash flow over the last year. That means it's on the risky side of things. 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. For example - KOAS has 1 warning sign we think you should be aware of.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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