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. Importantly, GNCO Co., Ltd. (KOSDAQ:065060) does carry debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
What Is GNCO's Debt?
The image below, which you can click on for greater detail, shows that GNCO had debt of ₩68.4b at the end of September 2020, a reduction from ₩84.4b over a year. On the flip side, it has ₩29.8b in cash leading to net debt of about ₩38.6b.
How Healthy Is GNCO's Balance Sheet?
According to the last reported balance sheet, GNCO had liabilities of ₩99.6b due within 12 months, and liabilities of ₩5.80b due beyond 12 months. Offsetting these obligations, it had cash of ₩29.8b as well as receivables valued at ₩33.9b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩41.7b.
While this might seem like a lot, it is not so bad since GNCO has a market capitalization of ₩95.6b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is GNCO'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.
In the last year GNCO had a loss before interest and tax, and actually shrunk its revenue by 11%, to ₩134b. That's not what we would hope to see.
Not only did GNCO's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost ₩7.2b 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. However, it doesn't help that it burned through ₩3.8b of cash over the last year. So to be blunt we think it is 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. Case in point: We've spotted 2 warning signs for GNCO you should be aware of, and 1 of them is potentially serious.
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.
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