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. Importantly, Seouleaguer Co., Ltd. (KOSDAQ:043710) 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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Seouleaguer Carry?
The image below, which you can click on for greater detail, shows that at December 2020 Seouleaguer had debt of ₩42.0b, up from ₩33.9b in one year. However, it does have ₩22.4b in cash offsetting this, leading to net debt of about ₩19.6b.
How Strong Is Seouleaguer's Balance Sheet?
According to the last reported balance sheet, Seouleaguer had liabilities of ₩43.2b due within 12 months, and liabilities of ₩21.7b due beyond 12 months. Offsetting this, it had ₩22.4b in cash and ₩13.5b in receivables that were due within 12 months. So its liabilities total ₩29.0b more than the combination of its cash and short-term receivables.
This deficit is considerable relative to its market capitalization of ₩38.8b, so it does suggest shareholders should keep an eye on Seouleaguer's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Seouleaguer will need earnings to service that debt. 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, Seouleaguer made a loss at the EBIT level, and saw its revenue drop to ₩44b, which is a fall of 40%. To be frank that doesn't bode well.
Not only did Seouleaguer's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping ₩30b. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled ₩7.5b in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Seouleaguer (at least 1 which doesn't sit too well with us) , and understanding them should be part of your investment process.
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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