We Think Sungdo Engineering & Construction (KOSDAQ:037350) Is Taking Some Risk With Its Debt

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. We note that Sungdo Engineering & Construction Co., Ltd. (KOSDAQ:037350) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Sungdo Engineering & Construction

What Is Sungdo Engineering & Construction's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Sungdo Engineering & Construction had ₩34.6b of debt, an increase on ₩20.0b, over one year. However, its balance sheet shows it holds ₩71.2b in cash, so it actually has ₩36.7b net cash.

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

We can see from the most recent balance sheet that Sungdo Engineering & Construction had liabilities of ₩167.9b falling due within a year, and liabilities of ₩129.1b due beyond that. On the other hand, it had cash of ₩71.2b and ₩42.7b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩183.0b.

The deficiency here weighs heavily on the ₩87.9b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. 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. Sungdo Engineering & Construction boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

On top of that, Sungdo Engineering & Construction grew its EBIT by 50% over the last twelve months, and that growth will make it easier to handle its debt. 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 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. While Sungdo Engineering & Construction has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Sungdo Engineering & Construction created free cash flow amounting to 8.5% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing up

While Sungdo Engineering & Construction does have more liabilities than liquid assets, it also has net cash of ₩36.7b. And it impressed us with its EBIT growth of 50% over the last year. So while Sungdo Engineering & Construction does not have a great balance sheet, it's certainly not too bad. 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. For example, we've discovered 4 warning signs for Sungdo Engineering & Construction (1 is a bit unpleasant!) that you should be aware of before investing here.

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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