Here's Why Seoul Semiconductor (KOSDAQ:046890) Can Manage Its Debt Responsibly

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.' 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 Seoul Semiconductor Co., Ltd. (KOSDAQ:046890) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Seoul Semiconductor

How Much Debt Does Seoul Semiconductor Carry?

The chart below, which you can click on for greater detail, shows that Seoul Semiconductor had ₩201.5b in debt in December 2020; about the same as the year before. However, it also had ₩80.2b in cash, and so its net debt is ₩121.3b.

How Healthy Is Seoul Semiconductor's Balance Sheet?

The latest balance sheet data shows that Seoul Semiconductor had liabilities of ₩503.5b due within a year, and liabilities of ₩35.9b falling due after that. On the other hand, it had cash of ₩80.2b and ₩408.4b worth of receivables due within a year. So its liabilities total ₩50.7b more than the combination of its cash and short-term receivables.

Since publicly traded Seoul Semiconductor shares are worth a total of ₩1.08t, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Seoul Semiconductor has a low net debt to EBITDA ratio of only 0.87. And its EBIT covers its interest expense a whopping 24.0 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Also positive, Seoul Semiconductor grew its EBIT by 21% in the last year, and that should make it easier to pay down debt, going forward. 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 Seoul Semiconductor'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Seoul Semiconductor recorded free cash flow of 28% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

The good news is that Seoul Semiconductor's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. Taking all this data into account, it seems to us that Seoul Semiconductor takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Seoul Semiconductor that you should be aware of before investing here.

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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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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