These 4 Measures Indicate That SamYoung ChemicalLtd (KRX:003720) Is Using Debt Extensively

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 can see that SamYoung Chemical Co.,Ltd (KRX:003720) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. 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 SamYoung ChemicalLtd

How Much Debt Does SamYoung ChemicalLtd Carry?

As you can see below, SamYoung ChemicalLtd had ₩33.0b of debt at September 2020, down from ₩36.5b a year prior. However, because it has a cash reserve of ₩2.26b, its net debt is less, at about ₩30.7b.

How Strong Is SamYoung ChemicalLtd's Balance Sheet?

The latest balance sheet data shows that SamYoung ChemicalLtd had liabilities of ₩49.5b due within a year, and liabilities of ₩10.8b falling due after that. Offsetting these obligations, it had cash of ₩2.26b as well as receivables valued at ₩28.1b due within 12 months. So it has liabilities totalling ₩29.9b more than its cash and near-term receivables, combined.

This deficit isn't so bad because SamYoung ChemicalLtd is worth ₩85.6b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

SamYoung ChemicalLtd has a debt to EBITDA ratio of 3.4 and its EBIT covered its interest expense 3.5 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. One redeeming factor for SamYoung ChemicalLtd is that it turned last year's EBIT loss into a gain of ₩2.3b, over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is SamYoung ChemicalLtd's earnings that will influence how the balance sheet holds up in the future. 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 it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, SamYoung ChemicalLtd 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

Mulling over SamYoung ChemicalLtd's attempt at converting EBIT to free cash flow, we're certainly not enthusiastic. Having said that, its ability to grow its EBIT isn't such a worry. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making SamYoung ChemicalLtd stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that SamYoung ChemicalLtd is showing 3 warning signs in our investment analysis , you should know about...

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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