SM Entertainment (KOSDAQ:041510) Could Easily Take On More Debt

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 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 SM Entertainment Co., Ltd. (KOSDAQ:041510) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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

Check out our latest analysis for SM Entertainment

What Is SM Entertainment's Debt?

As you can see below, at the end of December 2023, SM Entertainment had ₩46.9b of debt, up from ₩8.60b a year ago. Click the image for more detail. However, its balance sheet shows it holds ₩500.6b in cash, so it actually has ₩453.8b net cash.

A Look At SM Entertainment's Liabilities

We can see from the most recent balance sheet that SM Entertainment had liabilities of ₩519.3b falling due within a year, and liabilities of ₩112.3b due beyond that. Offsetting these obligations, it had cash of ₩500.6b as well as receivables valued at ₩153.4b due within 12 months. So it can boast ₩22.4b more liquid assets than total liabilities.

Having regard to SM Entertainment's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the ₩1.84t company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that SM Entertainment has more cash than debt is arguably a good indication that it can manage its debt safely.

Another good sign is that SM Entertainment has been able to increase its EBIT by 25% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine SM Entertainment's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs 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. Over the most recent three years, SM Entertainment recorded free cash flow worth 76% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case SM Entertainment has ₩453.8b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of ₩62b, being 76% of its EBIT. So we don't think SM Entertainment's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for SM Entertainment 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.