Codenature (KOSDAQ:078940) Is Carrying A Fair Bit Of Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Codenature Inc. (KOSDAQ:078940) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Codenature

What Is Codenature's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Codenature had debt of ₩17.3b, up from ₩12.2b in one year. However, because it has a cash reserve of ₩2.16b, its net debt is less, at about ₩15.1b.

How Strong Is Codenature's Balance Sheet?

The latest balance sheet data shows that Codenature had liabilities of ₩19.6b due within a year, and liabilities of ₩3.88b falling due after that. Offsetting these obligations, it had cash of ₩2.16b as well as receivables valued at ₩11.3b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩10.0b.

Since publicly traded Codenature shares are worth a total of ₩72.5b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Codenature will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Codenature had a loss before interest and tax, and actually shrunk its revenue by 9.9%, to ₩38b. That's not what we would hope to see.

Caveat Emptor

Importantly, Codenature had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at ₩2.9b. 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 ₩5.6b in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 4 warning signs for Codenature (1 makes us a bit uncomfortable!) that you should be aware of before investing here.

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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