Here's Why Codes Combine (KOSDAQ:047770) Can Manage Its Debt Responsibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that Codes Combine Co., Ltd. (KOSDAQ:047770) does use debt in its business. 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Codes Combine

How Much Debt Does Codes Combine Carry?

The chart below, which you can click on for greater detail, shows that Codes Combine had ₩9.27b in debt in September 2020; about the same as the year before. But it also has ₩9.84b in cash to offset that, meaning it has ₩572.9m net cash.

How Strong Is Codes Combine's Balance Sheet?

According to the last reported balance sheet, Codes Combine had liabilities of ₩15.5b due within 12 months, and liabilities of ₩13.5b due beyond 12 months. Offsetting this, it had ₩9.84b in cash and ₩3.05b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩16.1b.

Given Codes Combine has a market capitalization of ₩93.6b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Codes Combine also has more cash than debt, so we're pretty confident it can manage its debt safely.

In fact Codes Combine's saving grace is its low debt levels, because its EBIT has tanked 36% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But it is Codes Combine's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Codes Combine 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. During the last three years, Codes Combine generated free cash flow amounting to a very robust 83% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

Although Codes Combine's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of ₩572.9m. And it impressed us with free cash flow of ₩3.4b, being 83% of its EBIT. So we are not troubled with Codes Combine's debt use. 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, we've discovered 1 warning sign for Codes Combine that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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