Is Sunchang (KRX:002820) Using Debt In A Risky Way?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that Sunchang Corporation (KRX:002820) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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, 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.

Check out our latest analysis for Sunchang

What Is Sunchang's Net Debt?

As you can see below, Sunchang had ₩220.6b of debt at September 2020, down from ₩238.7b a year prior. However, it does have ₩64.8b in cash offsetting this, leading to net debt of about ₩155.8b.

How Strong Is Sunchang's Balance Sheet?

We can see from the most recent balance sheet that Sunchang had liabilities of ₩219.2b falling due within a year, and liabilities of ₩89.2b due beyond that. Offsetting these obligations, it had cash of ₩64.8b as well as receivables valued at ₩85.3b due within 12 months. So it has liabilities totalling ₩158.4b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the ₩55.3b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Sunchang would likely require a major re-capitalisation if it had to pay its creditors today. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Sunchang 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.

Over 12 months, Sunchang made a loss at the EBIT level, and saw its revenue drop to ₩423b, which is a fall of 12%. We would much prefer see growth.

Caveat Emptor

While Sunchang's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable ₩9.3b at the EBIT level. If you consider the significant liabilities mentioned above, we are extremely wary of this investment. Of course, it may be able to improve its situation with a bit of luck and good execution. Nevertheless, we would not bet on it given that it vaporized ₩12b in cash over the last twelve months, and it doesn't have much by way of liquid assets. So we think this stock is risky, like walking through a dirty dog park with a mask on. 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 - Sunchang has 2 warning signs (and 1 which is significant) we think you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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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