Is SK-ElectronicsLTD (TYO:6677) Using Too Much Debt?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 note that SK-Electronics CO.,LTD. (TYO:6677) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for SK-ElectronicsLTD

How Much Debt Does SK-ElectronicsLTD Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 SK-ElectronicsLTD had JP¥4.45b of debt, an increase on JP¥750.0m, over one year. But it also has JP¥10.3b in cash to offset that, meaning it has JP¥5.88b net cash.

How Healthy Is SK-ElectronicsLTD's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that SK-ElectronicsLTD had liabilities of JP¥5.92b due within 12 months and liabilities of JP¥3.47b due beyond that. Offsetting these obligations, it had cash of JP¥10.3b as well as receivables valued at JP¥3.94b due within 12 months. So it can boast JP¥4.88b more liquid assets than total liabilities.

This luscious liquidity implies that SK-ElectronicsLTD's balance sheet is sturdy like a giant sequoia tree. On this view, lenders should feel as safe as the beloved of a black-belt karate master. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, SK-ElectronicsLTD made a loss at the EBIT level, and saw its revenue drop to JP¥19b, which is a fall of 26%. 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 we do note that SK-ElectronicsLTD had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through JP¥1.4b of cash and made a loss of JP¥971m. Given it only has net cash of JP¥5.88b, the company may need to raise more capital if it doesn't reach break-even soon. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with SK-ElectronicsLTD , and understanding them should be part of your investment process.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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