Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 note that Cherrybro co.,Ltd (KOSDAQ:066360) does have debt on its balance sheet. But is this debt a concern to shareholders?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is CherrybroLtd's Debt?
You can click the graphic below for the historical numbers, but it shows that as of September 2020 CherrybroLtd had ₩168.9b of debt, an increase on ₩144.1b, over one year. However, because it has a cash reserve of ₩15.8b, its net debt is less, at about ₩153.1b.
A Look At CherrybroLtd's Liabilities
Zooming in on the latest balance sheet data, we can see that CherrybroLtd had liabilities of ₩177.1b due within 12 months and liabilities of ₩48.7b due beyond that. On the other hand, it had cash of ₩15.8b and ₩25.5b worth of receivables due within a year. So it has liabilities totalling ₩184.5b more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the ₩63.0b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, CherrybroLtd would probably need a major re-capitalization if its creditors were to demand repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is CherrybroLtd'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.
In the last year CherrybroLtd's revenue was pretty flat, and it made a negative EBIT. While that's not too bad, we'd prefer see growth.
Importantly, CherrybroLtd had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable ₩27b at the EBIT level. Combining this information with the significant liabilities we already touched on makes us very hesitant about this stock, to say the least. That said, it is possible that the company will turn its fortunes around. Nevertheless, we would not bet on it given that it vaporized ₩31b in cash over the last twelve months, and it doesn't have much by way of liquid assets. So we consider this a high risk stock and we wouldn't be at all surprised if the company asks shareholders for money before long. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for CherrybroLtd (of which 2 shouldn't be ignored!) you should know about.
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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