Is Samsung SDI (KRX:006400) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 can see that Samsung SDI Co., Ltd. (KRX:006400) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Samsung SDI

How Much Debt Does Samsung SDI Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Samsung SDI had ₩3.91t of debt, an increase on ₩3.45t, over one year. However, it does have ₩1.47t in cash offsetting this, leading to net debt of about ₩2.44t.

How Strong Is Samsung SDI's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Samsung SDI had liabilities of ₩4.92t due within 12 months and liabilities of ₩2.92t due beyond that. Offsetting this, it had ₩1.47t in cash and ₩1.82t in receivables that were due within 12 months. So it has liabilities totalling ₩4.55t more than its cash and near-term receivables, combined.

Given Samsung SDI has a humongous market capitalization of ₩49t, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Samsung SDI's net debt to EBITDA ratio of about 1.7 suggests only moderate use of debt. And its strong interest cover of 11.1 times, makes us even more comfortable. It is just as well that Samsung SDI's load is not too heavy, because its EBIT was down 35% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Samsung SDI 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Samsung SDI saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Samsung SDI's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Once we consider all the factors above, together, it seems to us that Samsung SDI's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. 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. Be aware that Samsung SDI is showing 2 warning signs in our investment analysis , you should know about...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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