Seoul Semiconductor (KOSDAQ:046890) Seems To Use Debt Quite Sensibly

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. Importantly, Seoul Semiconductor Co., Ltd. (KOSDAQ:046890) does carry debt. But is this debt a concern to shareholders?

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. 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. 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.

Check out our latest analysis for Seoul Semiconductor

What Is Seoul Semiconductor's Net Debt?

The chart below, which you can click on for greater detail, shows that Seoul Semiconductor had ₩211.2b in debt in September 2020; about the same as the year before. On the flip side, it has ₩101.4b in cash leading to net debt of about ₩109.8b.

How Strong Is Seoul Semiconductor's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Seoul Semiconductor had liabilities of ₩508.3b due within 12 months and liabilities of ₩108.1b due beyond that. Offsetting this, it had ₩101.4b in cash and ₩451.6b in receivables that were due within 12 months. So it has liabilities totalling ₩63.3b more than its cash and near-term receivables, combined.

Since publicly traded Seoul Semiconductor shares are worth a total of ₩1.22t, 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 0.79. And its EBIT covers its interest expense a whopping 17.0 times over. So we're pretty relaxed about its super-conservative use of debt. On the other hand, Seoul Semiconductor's EBIT dived 11%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Seoul Semiconductor's free cash flow amounted to 37% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

On our analysis Seoul Semiconductor's interest cover should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. For instance it seems like it has to struggle a bit to grow its EBIT. Considering this range of data points, we think Seoul Semiconductor is in a good position to manage its debt levels. 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 instance, we've identified 1 warning sign for Seoul Semiconductor that 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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