Is Leaders Cosmetics (KOSDAQ:016100) Using Too Much Debt?

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Leaders Cosmetics Co., Ltd. (KOSDAQ:016100) makes use of debt. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

See our latest analysis for Leaders Cosmetics

What Is Leaders Cosmetics's Debt?

The chart below, which you can click on for greater detail, shows that Leaders Cosmetics had ₩54.1b in debt in December 2020; about the same as the year before. However, because it has a cash reserve of ₩22.0b, its net debt is less, at about ₩32.0b.

How Healthy Is Leaders Cosmetics' Balance Sheet?

The latest balance sheet data shows that Leaders Cosmetics had liabilities of ₩62.3b due within a year, and liabilities of ₩15.9b falling due after that. Offsetting these obligations, it had cash of ₩22.0b as well as receivables valued at ₩8.16b due within 12 months. So it has liabilities totalling ₩47.9b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of ₩66.8b. 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 Leaders Cosmetics'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 Leaders Cosmetics's revenue was pretty flat, and it made a negative EBIT. While that's not too bad, we'd prefer see growth.

Caveat Emptor

Importantly, Leaders Cosmetics had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping ₩11b. 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. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through ₩9.0b of cash over the last year. So suffice it to say we consider the stock very risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 2 warning signs with Leaders Cosmetics (at least 1 which is significant) , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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