Is SK-ElectronicsLTD (TYO:6677) 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.' 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. Importantly, SK-Electronics CO.,LTD. (TYO:6677) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for SK-ElectronicsLTD

How Much Debt Does SK-ElectronicsLTD Carry?

The image below, which you can click on for greater detail, shows that at December 2020 SK-ElectronicsLTD had debt of JP¥4.18b, up from JP¥675.0m in one year. However, it does have JP¥9.02b in cash offsetting this, leading to net cash of JP¥4.84b.

How Healthy Is SK-ElectronicsLTD's Balance Sheet?

According to the last reported balance sheet, SK-ElectronicsLTD had liabilities of JP¥6.14b due within 12 months, and liabilities of JP¥3.20b due beyond 12 months. On the other hand, it had cash of JP¥9.02b and JP¥4.76b worth of receivables due within a year. So it actually has JP¥4.43b more liquid assets than total liabilities.

This luscious liquidity implies that SK-ElectronicsLTD's balance sheet is sturdy like a giant sequoia tree. With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Simply put, the fact that SK-ElectronicsLTD has more cash than debt is arguably a good indication that it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if SK-ElectronicsLTD can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

In the last year SK-ElectronicsLTD had a loss before interest and tax, and actually shrunk its revenue by 25%, to JP¥18b. To be frank that doesn't bode well.

So How Risky Is SK-ElectronicsLTD?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And the fact is that over the last twelve months SK-ElectronicsLTD lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through JP¥1.4b of cash and made a loss of JP¥799m. With only JP¥4.84b on the balance sheet, it would appear that its going to need to raise capital again soon. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. 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 1 warning sign for SK-ElectronicsLTD you should be aware of.

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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