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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that SOLiD, Inc. (KOSDAQ:050890) does use debt in its business. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is SOLiD's Debt?
The image below, which you can click on for greater detail, shows that at September 2020 SOLiD had debt of ₩79.9b, up from ₩63.4b in one year. However, it also had ₩48.1b in cash, and so its net debt is ₩31.8b.
A Look At SOLiD's Liabilities
Zooming in on the latest balance sheet data, we can see that SOLiD had liabilities of ₩150.7b due within 12 months and liabilities of ₩19.5b due beyond that. Offsetting these obligations, it had cash of ₩48.1b as well as receivables valued at ₩28.5b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩93.5b.
Given SOLiD has a market capitalization of ₩484.0b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since SOLiD 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 SOLiD had a loss before interest and tax, and actually shrunk its revenue by 2.0%, to ₩196b. We would much prefer see growth.
Importantly, SOLiD had an earnings before interest and tax (EBIT) loss over the last year. To be specific the EBIT loss came in at ₩329m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. Surprisingly, we note that it actually reported positive free cash flow of ₩881m and a profit of ₩3.0b. So if we focus on those metrics there seems to be a chance the company will manage its debt without much trouble. 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 2 warning signs for SOLiD (of which 1 is a bit unpleasant!) you should know about.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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