Is Sejoong (KOSDAQ:039310) A Risky Investment?

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.' 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, Sejoong Co., Ltd. (KOSDAQ:039310) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Sejoong

What Is Sejoong's Net Debt?

The image below, which you can click on for greater detail, shows that Sejoong had debt of ₩10.0b at the end of December 2020, a reduction from ₩14.0b over a year. However, its balance sheet shows it holds ₩45.8b in cash, so it actually has ₩35.8b net cash.

How Strong Is Sejoong's Balance Sheet?

We can see from the most recent balance sheet that Sejoong had liabilities of ₩21.9b falling due within a year, and liabilities of ₩14.7b due beyond that. Offsetting these obligations, it had cash of ₩45.8b as well as receivables valued at ₩20.3b due within 12 months. So it actually has ₩29.4b more liquid assets than total liabilities.

This surplus liquidity suggests that Sejoong's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Sejoong has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Sejoong's load is not too heavy, because its EBIT was down 73% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Sejoong 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Sejoong has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Sejoong burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Sejoong has net cash of ₩35.8b, as well as more liquid assets than liabilities. So we are not troubled with Sejoong's debt use. 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. Case in point: We've spotted 3 warning signs for Sejoong you should be aware of, and 1 of them is a bit concerning.

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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