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

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 can see that SamYoung Chemical Co.,Ltd (KRX:003720) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for SamYoung ChemicalLtd

What Is SamYoung ChemicalLtd's Net Debt?

As you can see below, SamYoung ChemicalLtd had ₩31.1b of debt at December 2020, down from ₩35.5b a year prior. However, it does have ₩3.28b in cash offsetting this, leading to net debt of about ₩27.8b.

How Strong Is SamYoung ChemicalLtd's Balance Sheet?

We can see from the most recent balance sheet that SamYoung ChemicalLtd had liabilities of ₩50.6b falling due within a year, and liabilities of ₩12.6b due beyond that. Offsetting this, it had ₩3.28b in cash and ₩27.3b in receivables that were due within 12 months. So its liabilities total ₩32.6b more than the combination of its cash and short-term receivables.

SamYoung ChemicalLtd has a market capitalization of ₩92.1b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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.

SamYoung ChemicalLtd's debt is 3.4 times its EBITDA, and its EBIT cover its interest expense 3.4 times over. 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 ₩1.3b, over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. 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's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, SamYoung ChemicalLtd actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

When it comes to the balance sheet, the standout positive for SamYoung ChemicalLtd was the fact that it seems able to convert EBIT to free cash flow confidently. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit to cover its interest expense with its EBIT. When we consider all the elements mentioned above, it seems to us that SamYoung ChemicalLtd is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example - SamYoung ChemicalLtd has 4 warning signs we think you should be aware of.

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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