Is Lumens (KOSDAQ:038060) Using Debt Sensibly?

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 note that Lumens Co., Ltd. (KOSDAQ:038060) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. 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.

View our latest analysis for Lumens

How Much Debt Does Lumens Carry?

You can click the graphic below for the historical numbers, but it shows that Lumens had ₩64.2b of debt in December 2020, down from ₩74.0b, one year before. However, it also had ₩31.3b in cash, and so its net debt is ₩32.9b.

A Look At Lumens' Liabilities

Zooming in on the latest balance sheet data, we can see that Lumens had liabilities of ₩133.2b due within 12 months and liabilities of ₩7.98b due beyond that. Offsetting these obligations, it had cash of ₩31.3b as well as receivables valued at ₩44.8b due within 12 months. So it has liabilities totalling ₩65.0b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of ₩70.3b. 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 Lumens'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 Lumens wasn't profitable at an EBIT level, but managed to grow its revenue by 2.5%, to ₩332b. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Over the last twelve months Lumens produced an earnings before interest and tax (EBIT) loss. Its EBIT loss was a whopping ₩15b. 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. For example, we would not want to see a repeat of last year's loss of ₩17b. So we do think this stock is quite risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Lumens (of which 1 is a bit unpleasant!) you should know about.

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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