Is Sungdo Engineering & Construction (KOSDAQ:037350) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. As with many other companies Sungdo Engineering & Construction Co., Ltd. (KOSDAQ:037350) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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 Sungdo Engineering & Construction

What Is Sungdo Engineering & Construction's Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Sungdo Engineering & Construction had debt of ₩110.1b, up from ₩50.3b in one year. However, it does have ₩85.1b in cash offsetting this, leading to net debt of about ₩25.1b.

A Look At Sungdo Engineering & Construction's Liabilities

According to the last reported balance sheet, Sungdo Engineering & Construction had liabilities of ₩323.3b due within 12 months, and liabilities of ₩96.4b due beyond 12 months. Offsetting these obligations, it had cash of ₩85.1b as well as receivables valued at ₩182.6b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩152.0b.

This deficit casts a shadow over the ₩66.0b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Sungdo Engineering & Construction would likely require a major re-capitalisation if it had to pay its creditors today.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Sungdo Engineering & Construction's net debt is only 0.65 times its EBITDA. And its EBIT covers its interest expense a whopping 14.1 times over. So we're pretty relaxed about its super-conservative use of debt. It was also good to see that despite losing money on the EBIT line last year, Sungdo Engineering & Construction turned things around in the last 12 months, delivering and EBIT of ₩36b. When analysing debt levels, the balance sheet is the obvious place to start. But it is Sungdo Engineering & Construction's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Happily for any shareholders, Sungdo Engineering & Construction actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

While Sungdo Engineering & Construction's level of total liabilities has us nervous. To wit both its interest cover and conversion of EBIT to free cash flow were encouraging signs. Looking at all the angles mentioned above, it does seem to us that Sungdo Engineering & Construction is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 4 warning signs with Sungdo Engineering & Construction , 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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.