Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, Samsung Electronics Co., Ltd. (KRX:005930) does carry debt. But should shareholders be worried about its use of debt?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Samsung Electronics Carry?
The image below, which you can click on for greater detail, shows that at March 2021 Samsung Electronics had debt of ₩17t, up from ₩13t in one year. However, its balance sheet shows it holds ₩132t in cash, so it actually has ₩115t net cash.
How Strong Is Samsung Electronics' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Samsung Electronics had liabilities of ₩16t due within 12 months and liabilities of ₩103t due beyond that. Offsetting these obligations, it had cash of ₩132t as well as receivables valued at ₩34t due within 12 months. So it actually has ₩47t more liquid assets than total liabilities.
This short term liquidity is a sign that Samsung Electronics could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Samsung Electronics boasts net cash, so it's fair to say it does not have a heavy debt load!
On top of that, Samsung Electronics grew its EBIT by 39% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Samsung Electronics can strengthen its balance sheet over time. 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. Samsung Electronics may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Samsung Electronics recorded free cash flow worth 65% 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.
While we empathize with investors who find debt concerning, you should keep in mind that Samsung Electronics has net cash of ₩115t, as well as more liquid assets than liabilities. And we liked the look of last year's 39% year-on-year EBIT growth. So we don't think Samsung Electronics's use of debt is risky. 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. We've identified 1 warning sign with Samsung Electronics , and understanding them should be part of your investment process.
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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