Is Samchuly Bicycle (KOSDAQ:024950) 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 note that Samchuly Bicycle Co., Ltd (KOSDAQ:024950) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Samchuly Bicycle

What Is Samchuly Bicycle's Debt?

The image below, which you can click on for greater detail, shows that Samchuly Bicycle had debt of ₩36.7b at the end of September 2020, a reduction from ₩55.0b over a year. However, it also had ₩6.28b in cash, and so its net debt is ₩30.5b.

How Healthy Is Samchuly Bicycle's Balance Sheet?

We can see from the most recent balance sheet that Samchuly Bicycle had liabilities of ₩50.0b falling due within a year, and liabilities of ₩4.80b due beyond that. Offsetting this, it had ₩6.28b in cash and ₩11.5b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩37.1b.

This deficit isn't so bad because Samchuly Bicycle is worth ₩110.8b, and thus could probably raise enough capital to shore up 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Samchuly Bicycle's debt is 2.6 times its EBITDA, and its EBIT cover its interest expense 4.6 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. One redeeming factor for Samchuly Bicycle is that it turned last year's EBIT loss into a gain of ₩9.7b, over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Samchuly Bicycle'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. 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, Samchuly Bicycle actually produced more free cash flow than EBIT over the last year. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

On our analysis Samchuly Bicycle's conversion of EBIT to free cash flow should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit handle its debt, based on its EBITDA,. When we consider all the elements mentioned above, it seems to us that Samchuly Bicycle is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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, we've discovered 1 warning sign for Samchuly Bicycle that you should be aware of before investing here.

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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