Is Sempio (KRX:007540) Using Too Much 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 can see that Sempio Company (KRX:007540) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Sempio

How Much Debt Does Sempio Carry?

The image below, which you can click on for greater detail, shows that Sempio had debt of ₩11.7b at the end of December 2020, a reduction from ₩16.0b over a year. However, it does have ₩89.0b in cash offsetting this, leading to net cash of ₩77.3b.

A Look At Sempio's Liabilities

The latest balance sheet data shows that Sempio had liabilities of ₩56.0b due within a year, and liabilities of ₩34.1b falling due after that. Offsetting these obligations, it had cash of ₩89.0b as well as receivables valued at ₩38.8b due within 12 months. So it can boast ₩37.6b more liquid assets than total liabilities.

This excess liquidity is a great indication that Sempio's balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Sempio has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Sempio grew its EBIT by 39% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is Sempio'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Sempio may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Sempio generated free cash flow amounting to a very robust 80% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Sempio has net cash of ₩77.3b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of ₩35b, being 80% of its EBIT. When it comes to Sempio's debt, we sufficiently relaxed that our mind turns to the jacuzzi. Over time, share prices tend to follow earnings per share, so if you're interested in Sempio, you may well want to click here to check an interactive graph of its earnings per share history.

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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