Is Design (KOSDAQ:227100) A Risky Investment?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Design Co., Ltd. (KOSDAQ:227100) does use debt in its business. But is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Design

What Is Design's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Design had debt of ₩8.84b, up from ₩8.35b in one year. On the flip side, it has ₩3.31b in cash leading to net debt of about ₩5.53b.

How Strong Is Design's Balance Sheet?

We can see from the most recent balance sheet that Design had liabilities of ₩15.9b falling due within a year, and liabilities of ₩5.57b due beyond that. Offsetting these obligations, it had cash of ₩3.31b as well as receivables valued at ₩3.94b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩14.2b.

This deficit is considerable relative to its market capitalization of ₩20.7b, so it does suggest shareholders should keep an eye on Design's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Design's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Over 12 months, Design reported revenue of ₩38b, which is a gain of 65%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

While we can certainly appreciate Design's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Its EBIT loss was a whopping ₩3.6b. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. However, it doesn't help that it burned through ₩6.4b of cash over the last year. So in short it's a really risky stock. 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 Design is showing 5 warning signs in our investment analysis , and 2 of those are a bit unpleasant...

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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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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