Is Sungdo Engineering & Construction (KOSDAQ:037350) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Sungdo Engineering & Construction Co., Ltd. (KOSDAQ:037350) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Sungdo Engineering & Construction

What Is Sungdo Engineering & Construction's Net Debt?

As you can see below, at the end of March 2024, Sungdo Engineering & Construction had ₩122.8b of debt, up from ₩20.0b a year ago. Click the image for more detail. However, it does have ₩104.0b in cash offsetting this, leading to net debt of about ₩18.8b.

How Healthy Is Sungdo Engineering & Construction's Balance Sheet?

The latest balance sheet data shows that Sungdo Engineering & Construction had liabilities of ₩314.2b due within a year, and liabilities of ₩92.8b falling due after that. On the other hand, it had cash of ₩104.0b and ₩172.2b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩130.9b.

This deficit casts a shadow over the ₩69.7b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Sungdo Engineering & Construction would probably need a major re-capitalization if its creditors were to demand repayment.

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.

With net debt sitting at just 1.0 times EBITDA, Sungdo Engineering & Construction is arguably pretty conservatively geared. And it boasts interest cover of 7.2 times, which is more than adequate. Although Sungdo Engineering & Construction made a loss at the EBIT level, last year, it was also good to see that it generated ₩15b in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Sungdo Engineering & Construction's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by 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

Sungdo Engineering & Construction's level of total liabilities and EBIT growth rate definitely weigh on it, in our esteem. But its conversion of EBIT to free cash flow tells a very different story, and suggests some resilience. Taking the abovementioned factors together we do think Sungdo Engineering & Construction's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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. To that end, you should be aware of the 3 warning signs we've spotted with Sungdo Engineering & Construction .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.