Is LMS (KOSDAQ:073110) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that LMS Co., Ltd. (KOSDAQ:073110) does use debt in its business. But the real question is whether this debt is making the company risky.

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for LMS

What Is LMS's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 LMS had debt of ₩81.5b, up from ₩54.8b in one year. However, because it has a cash reserve of ₩69.1b, its net debt is less, at about ₩12.4b.

How Healthy Is LMS' Balance Sheet?

The latest balance sheet data shows that LMS had liabilities of ₩131.9b due within a year, and liabilities of ₩17.5b falling due after that. Offsetting this, it had ₩69.1b in cash and ₩65.4b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩14.9b.

Since publicly traded LMS shares are worth a total of ₩77.7b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. The balance sheet is clearly the area to focus on when you are analysing debt. But it is LMS'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 LMS had a loss before interest and tax, and actually shrunk its revenue by 6.4%, to ₩140b. We would much prefer see growth.

Caveat Emptor

Over the last twelve months LMS produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable ₩24b at the EBIT level. 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 ₩8.9b 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. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 4 warning signs for LMS you should be aware of, and 1 of them doesn't sit too well with us.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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