Is SanDi PropertiesLtd (TPE:1438) Using Too Much Debt?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that SanDi Properties Co.,Ltd. (TPE:1438) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for SanDi PropertiesLtd

What Is SanDi PropertiesLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 SanDi PropertiesLtd had NT$294.9m of debt, an increase on none, over one year. However, because it has a cash reserve of NT$61.8m, its net debt is less, at about NT$233.1m.

How Strong Is SanDi PropertiesLtd's Balance Sheet?

According to the last reported balance sheet, SanDi PropertiesLtd had liabilities of NT$296.8m due within 12 months, and liabilities of NT$68.8m due beyond 12 months. On the other hand, it had cash of NT$61.8m and NT$392.0k worth of receivables due within a year. So it has liabilities totalling NT$303.4m more than its cash and near-term receivables, combined.

SanDi PropertiesLtd has a market capitalization of NT$1.27b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

SanDi PropertiesLtd has a debt to EBITDA ratio of 4.8, which signals significant debt, but is still pretty reasonable for most types of business. However, its interest coverage of 1k is very high, suggesting that the interest expense on the debt is currently quite low. Notably, SanDi PropertiesLtd made a loss at the EBIT level, last year, but improved that to positive EBIT of NT$48m in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is SanDi PropertiesLtd'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, SanDi PropertiesLtd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

SanDi PropertiesLtd's conversion of EBIT to free cash flow and net debt to EBITDA definitely weigh on it, in our esteem. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. When we consider all the factors discussed, it seems to us that SanDi PropertiesLtd is taking some risks with its use of debt. While that debt can boost returns, we think the company has enough leverage now. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 4 warning signs for SanDi PropertiesLtd (2 make us uncomfortable) you should be aware of.

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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