David Iben put it well when he said, “Volatility is not a risk that interests us. Our aim is to avoid the permanent loss of capital. ‘ Whenever we think about how risky a business is, we always like to look at the use of debt as over-indebtedness can lead to ruin. We make a note of that SAMRYOONG Co., Ltd (KOSDAQ: 014970) has debt on its balance sheet. But should shareholders be concerned about the use of debt?
Why does debt pose a risk?
Debt helps a company until the company struggles to pay it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While this isn’t too common, we often see indebted companies permanently diluting their shareholders by forcing lenders to raise capital at a distressed price. Of course, many companies use debt to fund their growth without any negative consequences. The first thing to do when considering how much debt a company uses is to put its cash and debt together.
What is SAMRYOONGLtd’s Net Debt?
As you can see below, SAMRYOONGLtd was owed 39.1 billion yen in September 2020, up from 42.2 billion yen the previous year. However, since it has a cash reserve of 19.8 billion yen, its net debt is less of about 19.3 billion yen.
How strong is SAMRYOONGLtd’s record?
The latest balance sheet data shows that SAMRYOONGLtd had liabilities of $ 46.8 billion due within one year and liabilities of $ 8.68 billion due thereafter. On the other hand, it had cash and cash equivalents of 19.8 billion and 14.7 billion in receivables due within a year. So its debt is $ 21.0 billion more than the combination of cash and short-term receivables.
Of course, SAMRYOONGLtd has a market capitalization of 121.0 billion, so these liabilities are likely to be manageable. Nonetheless, it is clear that we should continue to monitor his record so that it does not deteriorate.
We measure a company’s debt burden in relation to its profitability by looking at net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily earnings before interest and taxes (EBIT) cover its interest costs (Interest coverage). The advantage of this approach is that we take into account both the absolute level of debt (with net debt to EBITDA) and the actual interest expenses associated with this debt (with its interest coverage ratio).
While SAMRYOONGLtd’s debt to EBITDA ratio (2.5) suggests that some of the debt is being used, the interest coverage is very weak at 0.63, which suggests a high level of debt. This is in large part due to the company’s significant depreciation and amortization charges, which arguably mean that EBITDA is a very generous earnings metric and its debt may be a bigger burden than it first appears. It seems clear that the cost of borrowing has been negatively impacting shareholder returns recently. It is important that SAMRYOONGLtd’s EBIT has fallen by a staggering 71% in the last twelve months. If this decline continues, paying off the debt will be more difficult than selling foie gras at a vegan convention. Undoubtedly, we learn most about balance sheet debt. But you cannot look at debt in complete isolation; because SAMRYOONGLtd needs income to service this debt. So if you want to know more about earnings, it might be worth taking a look this graph of the long-term earnings trend.
After all, a company can only pay off debts with cold money, not book profits. We therefore always check how much of this EBIT is converted into free cash flow. In the past three years, SAMRYOONGLtd has burned a lot of money. While investors no doubt expect this situation to reverse in due course, it clearly means that using debt is riskier.
To be honest, both SAMRYOONGLtd’s EBIT to Free Cash Flow conversion and its track record of (non) rising EBIT make us pretty uncomfortable with debt levels. But at least the level of total debt isn’t that bad. We are pretty sure we rate SAMRYOONGLtd as quite risky based on its balance sheet health. Because of this, we are fairly cautious about the stock, and we believe that shareholders should keep a close eye on their liquidity. Undoubtedly, we learn most about balance sheet debt. However, not all of the investment risk is on the balance sheet – on the contrary. To do this, you should find out about the 6 warning signs we spotted with SAMRYOONGLtd (including 2 which are somewhat worrying) .
After all that, if you’re more interested in a fast-growing company with a rock-solid balance sheet, then drop by our list of net cash growth stocks without delay.
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