Samchuly Bicycle (KOSDAQ:024950) Seems To Use Debt Quite Sensibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, Samchuly Bicycle Co., Ltd (KOSDAQ:024950) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Samchuly Bicycle

What Is Samchuly Bicycle's Debt?

You can click the graphic below for the historical numbers, but it shows that Samchuly Bicycle had ₩17.8b of debt in December 2020, down from ₩53.7b, one year before. However, because it has a cash reserve of ₩8.21b, its net debt is less, at about ₩9.59b.

How Strong Is Samchuly Bicycle's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Samchuly Bicycle had liabilities of ₩29.0b due within 12 months and liabilities of ₩4.50b due beyond that. Offsetting this, it had ₩8.21b in cash and ₩8.81b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩16.5b.

Since publicly traded Samchuly Bicycle shares are worth a total of ₩159.4b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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.

Looking at its net debt to EBITDA of 0.74 and interest cover of 5.9 times, it seems to us that Samchuly Bicycle is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. It was also good to see that despite losing money on the EBIT line last year, Samchuly Bicycle turned things around in the last 12 months, delivering and EBIT of ₩11b. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Samchuly Bicycle can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

Happily, Samchuly Bicycle's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. And the good news does not stop there, as its net debt to EBITDA also supports that impression! Taking all this data into account, it seems to us that Samchuly Bicycle takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Samchuly Bicycle you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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This article by Simply Wall St is general in nature. 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.
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