Is Synergy Innovation (KOSDAQ:048870) 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.' 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 can see that Synergy Innovation Co., Ltd. (KOSDAQ:048870) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Synergy Innovation

How Much Debt Does Synergy Innovation Carry?

The image below, which you can click on for greater detail, shows that Synergy Innovation had debt of ₩25.2b at the end of September 2020, a reduction from ₩35.2b over a year. However, because it has a cash reserve of ₩24.0b, its net debt is less, at about ₩1.18b.

How Strong Is Synergy Innovation's Balance Sheet?

According to the last reported balance sheet, Synergy Innovation had liabilities of ₩26.2b due within 12 months, and liabilities of ₩20.7b due beyond 12 months. On the other hand, it had cash of ₩24.0b and ₩15.5b worth of receivables due within a year. So its liabilities total ₩7.42b more than the combination of its cash and short-term receivables.

Of course, Synergy Innovation has a market capitalization of ₩221.5b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Carrying virtually no net debt, Synergy Innovation has a very light debt load indeed.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Synergy Innovation has a very low debt to EBITDA ratio of 0.11 so it is strange to see weak interest coverage, with last year's EBIT being only 1.3 times the interest expense. So one way or the other, it's clear the debt levels are not trivial. Pleasingly, Synergy Innovation is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 654% gain in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Synergy Innovation's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Synergy Innovation burned a lot of cash. 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

Synergy Innovation's conversion of EBIT to free cash flow was a real negative on this analysis, as was its interest cover. But its EBIT growth rate was significantly redeeming. We would also note that Medical Equipment industry companies like Synergy Innovation commonly do use debt without problems. When we consider all the elements mentioned above, it seems to us that Synergy Innovation is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for Synergy Innovation that you should be aware of.

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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