SIMPAC (KRX:009160) Has A Somewhat Strained Balance Sheet

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 can see that SIMPAC Inc. (KRX:009160) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for SIMPAC

What Is SIMPAC's Debt?

You can click the graphic below for the historical numbers, but it shows that SIMPAC had ₩223.4b of debt in June 2024, down from ₩246.0b, one year before. However, because it has a cash reserve of ₩175.2b, its net debt is less, at about ₩48.2b.

How Healthy Is SIMPAC's Balance Sheet?

The latest balance sheet data shows that SIMPAC had liabilities of ₩371.7b due within a year, and liabilities of ₩21.7b falling due after that. Offsetting these obligations, it had cash of ₩175.2b as well as receivables valued at ₩100.1b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩118.1b.

SIMPAC has a market capitalization of ₩197.3b, 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.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

We'd say that SIMPAC's moderate net debt to EBITDA ratio ( being 1.7), indicates prudence when it comes to debt. And its commanding EBIT of 2k times its interest expense, implies the debt load is as light as a peacock feather. In fact SIMPAC's saving grace is its low debt levels, because its EBIT has tanked 63% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since SIMPAC will need earnings to service that debt. 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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, SIMPAC created free cash flow amounting to 8.9% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

We'd go so far as to say SIMPAC's EBIT growth rate was disappointing. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that SIMPAC's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - SIMPAC has 2 warning signs we think you should be aware of.

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.