These 4 Measures Indicate That Sy (KOSDAQ:109610) Is Using Debt Extensively

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.' 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. As with many other companies Sy Co., Ltd. (KOSDAQ:109610) makes use of debt. But should shareholders be worried about its use of debt?

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. 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. 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 Sy

What Is Sy's Debt?

The chart below, which you can click on for greater detail, shows that Sy had ₩142.7b in debt in September 2023; about the same as the year before. However, because it has a cash reserve of ₩33.7b, its net debt is less, at about ₩109.0b.

A Look At Sy's Liabilities

We can see from the most recent balance sheet that Sy had liabilities of ₩191.4b falling due within a year, and liabilities of ₩45.2b due beyond that. Offsetting this, it had ₩33.7b in cash and ₩117.2b in receivables that were due within 12 months. So its liabilities total ₩85.7b more than the combination of its cash and short-term receivables.

Sy has a market capitalization of ₩221.5b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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.

Sy's debt is 3.0 times its EBITDA, and its EBIT cover its interest expense 2.8 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. The silver lining is that Sy grew its EBIT by 158% last year, which nourishing like the idealism of youth. If it can keep walking that path it will be in a position to shed its debt with relative ease. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Sy will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Sy saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Neither Sy's ability to convert EBIT to free cash flow nor its interest cover gave us confidence in its ability to take on more debt. But its EBIT growth rate tells a very different story, and suggests some resilience. Taking the abovementioned factors together we do think Sy's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. 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. Be aware that Sy is showing 2 warning signs in our investment analysis , and 1 of those is a bit unpleasant...

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.