Is SM Entertainment (KOSDAQ:041510) A Risky Investment?

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.' 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. Importantly, SM Entertainment Co., Ltd. (KOSDAQ:041510) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 SM Entertainment

What Is SM Entertainment's Net Debt?

You can click the graphic below for the historical numbers, but it shows that SM Entertainment had ₩49.5b of debt in September 2020, down from ₩53.0b, one year before. But on the other hand it also has ₩334.3b in cash, leading to a ₩284.9b net cash position.

How Healthy Is SM Entertainment's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that SM Entertainment had liabilities of ₩365.9b due within 12 months and liabilities of ₩23.0b due beyond that. Offsetting this, it had ₩334.3b in cash and ₩85.9b in receivables that were due within 12 months. So it can boast ₩31.3b more liquid assets than total liabilities.

This surplus suggests that SM Entertainment has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that SM Entertainment has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that SM Entertainment's load is not too heavy, because its EBIT was down 59% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if SM Entertainment can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While SM Entertainment has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, SM Entertainment actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to investigate a company's debt, in this case SM Entertainment has ₩284.9b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of ₩38b, being 188% of its EBIT. So we are not troubled with SM Entertainment's debt use. While SM Entertainment didn't make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away. Click here to see if its earnings are heading in the right direction, over the medium term.

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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