These 4 Measures Indicate That SAMRYOONGLtd (KOSDAQ:014970) Is Using Debt Extensively

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 note that SAMRYOONG Co.,Ltd (KOSDAQ:014970) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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 SAMRYOONGLtd

What Is SAMRYOONGLtd's Net Debt?

As you can see below, SAMRYOONGLtd had ₩39.1b of debt at September 2020, down from ₩42.2b a year prior. However, because it has a cash reserve of ₩19.8b, its net debt is less, at about ₩19.3b.

How Strong Is SAMRYOONGLtd's Balance Sheet?

The latest balance sheet data shows that SAMRYOONGLtd had liabilities of ₩46.8b due within a year, and liabilities of ₩8.68b falling due after that. On the other hand, it had cash of ₩19.8b and ₩14.7b worth of receivables due within a year. So its liabilities total ₩21.0b more than the combination of its cash and short-term receivables.

Of course, SAMRYOONGLtd has a market capitalization of ₩121.0b, 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.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

While SAMRYOONGLtd's debt to EBITDA ratio (2.5) suggests that it uses some debt, its interest cover is very weak, at 0.63, suggesting high leverage. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. Importantly, SAMRYOONGLtd's EBIT fell a jaw-dropping 71% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since SAMRYOONGLtd will need earnings to service that debt. 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 company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last three years, SAMRYOONGLtd 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

To be frank both SAMRYOONGLtd's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least its level of total liabilities is not so bad. We're quite clear that we consider SAMRYOONGLtd to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 6 warning signs we've spotted with SAMRYOONGLtd (including 2 which are a bit concerning) .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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