Is Sebang (KRX:004360) Using Too Much Debt?

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. As with many other companies Sebang Co., Ltd (KRX:004360) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Sebang

What Is Sebang's Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Sebang had debt of ₩73.1b, up from ₩39.0b in one year. However, its balance sheet shows it holds ₩123.1b in cash, so it actually has ₩49.9b net cash.

How Strong Is Sebang's Balance Sheet?

The latest balance sheet data shows that Sebang had liabilities of ₩192.9b due within a year, and liabilities of ₩125.8b falling due after that. Offsetting these obligations, it had cash of ₩123.1b as well as receivables valued at ₩120.7b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩75.0b.

This deficit isn't so bad because Sebang is worth ₩187.8b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Sebang boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that Sebang grew its EBIT at 12% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Sebang's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Sebang 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 last three years, Sebang recorded free cash flow worth a fulsome 90% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing up

Although Sebang's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of ₩49.9b. The cherry on top was that in converted 90% of that EBIT to free cash flow, bringing in ₩33b. So is Sebang's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Sebang is showing 3 warning signs in our investment analysis , and 1 of those is potentially serious...

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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