Here's Why Sambo Corrugated Board (KOSDAQ:023600) Can Manage Its Debt Responsibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. As with many other companies Sambo Corrugated Board Co., Ltd. (KOSDAQ:023600) makes use of debt. 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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Sambo Corrugated Board

How Much Debt Does Sambo Corrugated Board Carry?

As you can see below, Sambo Corrugated Board had ₩60.4b of debt at September 2020, down from ₩68.8b a year prior. On the flip side, it has ₩45.7b in cash leading to net debt of about ₩14.8b.

How Healthy Is Sambo Corrugated Board's Balance Sheet?

We can see from the most recent balance sheet that Sambo Corrugated Board had liabilities of ₩69.1b falling due within a year, and liabilities of ₩79.7b due beyond that. On the other hand, it had cash of ₩45.7b and ₩73.8b worth of receivables due within a year. So its liabilities total ₩29.3b more than the combination of its cash and short-term receivables.

Given Sambo Corrugated Board has a market capitalization of ₩175.6b, it's hard to believe these liabilities pose much 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.

Sambo Corrugated Board has a low net debt to EBITDA ratio of only 0.25. And its EBIT covers its interest expense a whopping 55.0 times over. So we're pretty relaxed about its super-conservative use of debt. On the other hand, Sambo Corrugated Board's EBIT dived 16%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Sambo Corrugated Board 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. In the last three years, Sambo Corrugated Board's free cash flow amounted to 41% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

Both Sambo Corrugated Board's ability to to cover its interest expense with its EBIT and its net debt to EBITDA gave us comfort that it can handle its debt. But truth be told its EBIT growth rate had us nibbling our nails. When we consider all the factors mentioned above, we do feel a bit cautious about Sambo Corrugated Board's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Take risks, for example - Sambo Corrugated Board has 2 warning signs we think you should be aware of.

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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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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