Is Simmtech Holdings (KOSDAQ:036710) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Simmtech Holdings Co., Ltd. (KOSDAQ:036710) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Simmtech Holdings

What Is Simmtech Holdings's Net Debt?

As you can see below, Simmtech Holdings had ₩157.6b of debt at September 2020, down from ₩305.6b a year prior. However, it does have ₩15.8b in cash offsetting this, leading to net debt of about ₩141.8b.

How Healthy Is Simmtech Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Simmtech Holdings had liabilities of ₩385.8b due within 12 months and liabilities of ₩147.1b due beyond that. On the other hand, it had cash of ₩15.8b and ₩74.9b worth of receivables due within a year. So it has liabilities totalling ₩442.2b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the ₩113.1b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Simmtech Holdings would probably need a major re-capitalization if its creditors were to demand repayment.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

While Simmtech Holdings's low debt to EBITDA ratio of 0.87 suggests only modest use of debt, the fact that EBIT only covered the interest expense by 6.2 times last year does give us pause. So we'd recommend keeping a close eye on the impact financing costs are having on the business. It was also good to see that despite losing money on the EBIT line last year, Simmtech Holdings turned things around in the last 12 months, delivering and EBIT of ₩85b. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Simmtech Holdings will need earnings to service that debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, Simmtech Holdings produced sturdy free cash flow equating to 75% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Simmtech Holdings's level of total liabilities was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. In particular, its conversion of EBIT to free cash flow was re-invigorating. Taking the abovementioned factors together we do think Simmtech Holdings's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 3 warning signs for Simmtech Holdings 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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