Is Sungchang Enterprise Holdings (KRX:000180) A Risky Investment?

Warren Buffett famously said, '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. We note that Sungchang Enterprise Holdings Limited (KRX:000180) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Sungchang Enterprise Holdings

What Is Sungchang Enterprise Holdings's Debt?

As you can see below, Sungchang Enterprise Holdings had ₩83.8b of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. However, it does have ₩25.2b in cash offsetting this, leading to net debt of about ₩58.5b.

How Strong Is Sungchang Enterprise Holdings's Balance Sheet?

We can see from the most recent balance sheet that Sungchang Enterprise Holdings had liabilities of ₩99.3b falling due within a year, and liabilities of ₩81.5b due beyond that. On the other hand, it had cash of ₩25.2b and ₩31.7b worth of receivables due within a year. So its liabilities total ₩123.9b more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of ₩152.7b, so it does suggest shareholders should keep an eye on Sungchang Enterprise Holdings's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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.

While Sungchang Enterprise Holdings's debt to EBITDA ratio (3.5) suggests that it uses some debt, its interest cover is very weak, at 2.1, 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. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. One redeeming factor for Sungchang Enterprise Holdings is that it turned last year's EBIT loss into a gain of ₩5.4b, over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Sungchang Enterprise Holdings 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Sungchang Enterprise Holdings actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

Sungchang Enterprise Holdings's interest cover and level of total liabilities definitely weigh on it, in our esteem. But the good news is it seems to be able to convert EBIT to free cash flow with ease. Looking at all the angles mentioned above, it does seem to us that Sungchang Enterprise Holdings is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. For example, we've discovered 1 warning sign for Sungchang Enterprise Holdings that you should be aware of before investing here.

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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