These 4 Measures Indicate That SunjinLtd (KRX:136490) Is Using Debt Extensively

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Sunjin Co.,Ltd. (KRX:136490) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for SunjinLtd

What Is SunjinLtd's Net Debt?

You can click the graphic below for the historical numbers, but it shows that SunjinLtd had ₩515.6b of debt in September 2020, down from ₩616.8b, one year before. However, it does have ₩124.5b in cash offsetting this, leading to net debt of about ₩391.1b.

A Look At SunjinLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that SunjinLtd had liabilities of ₩597.8b due within 12 months and liabilities of ₩108.7b due beyond that. On the other hand, it had cash of ₩124.5b and ₩173.9b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩408.1b.

This is a mountain of leverage relative to its market capitalization of ₩500.6b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With net debt to EBITDA of 3.6 SunjinLtd has a fairly noticeable amount of debt. On the plus side, its EBIT was 7.3 times its interest expense, and its net debt to EBITDA, was quite high, at 3.6. Notably, SunjinLtd's EBIT launched higher than Elon Musk, gaining a whopping 133% on last year. 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 SunjinLtd 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, 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. Over the last three years, SunjinLtd saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

SunjinLtd's conversion of EBIT to free cash flow and net debt to EBITDA definitely weigh on it, in our esteem. But the good news is it seems to be able to grow its EBIT with ease. When we consider all the factors discussed, it seems to us that SunjinLtd is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. 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 SunjinLtd is showing 2 warning signs in our investment analysis , and 1 of those is a bit unpleasant...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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