Is Sungwoo Electronics (KOSDAQ:081580) Using Debt In A Risky Way?

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. We can see that Sungwoo Electronics Co., Ltd. (KOSDAQ:081580) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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 Sungwoo Electronics

How Much Debt Does Sungwoo Electronics Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Sungwoo Electronics had debt of ₩12.3b, up from ₩11.7b in one year. However, it does have ₩42.5b in cash offsetting this, leading to net cash of ₩30.2b.

How Strong Is Sungwoo Electronics' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sungwoo Electronics had liabilities of ₩24.7b due within 12 months and liabilities of ₩3.44b due beyond that. Offsetting these obligations, it had cash of ₩42.5b as well as receivables valued at ₩16.7b due within 12 months. So it actually has ₩31.1b more liquid assets than total liabilities.

This excess liquidity is a great indication that Sungwoo Electronics' balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Sungwoo Electronics has more cash than debt is arguably a good indication that it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Sungwoo Electronics will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Sungwoo Electronics had a loss before interest and tax, and actually shrunk its revenue by 12%, to ₩115b. We would much prefer see growth.

So How Risky Is Sungwoo Electronics?

Although Sungwoo Electronics had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of ₩6.0b. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. There's no doubt the next few years will be crucial to how the business matures. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Sungwoo Electronics (of which 1 makes us a bit uncomfortable!) you should know about.

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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