Soulbrain Holdings (KOSDAQ:036830) Seems To Use Debt Quite Sensibly

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.' 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 Soulbrain Holdings Co., Ltd. (KOSDAQ:036830) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Soulbrain Holdings

How Much Debt Does Soulbrain Holdings Carry?

The image below, which you can click on for greater detail, shows that at March 2024 Soulbrain Holdings had debt of ₩358.7b, up from ₩331.1b in one year. However, it also had ₩168.8b in cash, and so its net debt is ₩189.9b.

A Look At Soulbrain Holdings' Liabilities

The latest balance sheet data shows that Soulbrain Holdings had liabilities of ₩363.1b due within a year, and liabilities of ₩166.6b falling due after that. On the other hand, it had cash of ₩168.8b and ₩44.7b worth of receivables due within a year. So it has liabilities totalling ₩316.1b more than its cash and near-term receivables, combined.

Of course, Soulbrain Holdings has a market capitalization of ₩1.63t, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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.

Soulbrain Holdings has net debt of just 1.2 times EBITDA, indicating that it is certainly not a reckless borrower. And this view is supported by the solid interest coverage, with EBIT coming in at 7.7 times the interest expense over the last year. In addition to that, we're happy to report that Soulbrain Holdings has boosted its EBIT by 48%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is Soulbrain Holdings'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 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. Over the last three years, Soulbrain Holdings 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

Based on what we've seen Soulbrain Holdings is not finding it easy, given its conversion of EBIT to free cash flow, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its EBIT growth rate. Considering this range of data points, we think Soulbrain Holdings is in a good position to manage its debt levels. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. 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. For example - Soulbrain Holdings has 1 warning sign we think you should be aware of.

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.