Is Sanitar (TPE:1817) 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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Sanitar Co., Ltd. (TPE:1817) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Sanitar

What Is Sanitar's Debt?

As you can see below, at the end of September 2020, Sanitar had NT$413.4m of debt, up from NT$315.8m a year ago. Click the image for more detail. However, because it has a cash reserve of NT$186.2m, its net debt is less, at about NT$227.2m.

How Strong Is Sanitar's Balance Sheet?

According to the last reported balance sheet, Sanitar had liabilities of NT$640.7m due within 12 months, and liabilities of NT$236.5m due beyond 12 months. On the other hand, it had cash of NT$186.2m and NT$238.2m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$452.8m.

Of course, Sanitar has a market capitalization of NT$2.33b, so these liabilities are probably manageable. 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.

Sanitar's net debt is only 0.62 times its EBITDA. And its EBIT easily covers its interest expense, being 93.1 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Fortunately, Sanitar grew its EBIT by 5.6% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Sanitar will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Looking at the most recent three years, Sanitar recorded free cash flow of 21% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

On our analysis Sanitar's interest cover should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. For instance it seems like it has to struggle a bit to convert EBIT to free cash flow. When we consider all the elements mentioned above, it seems to us that Sanitar is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. We've identified 3 warning signs with Sanitar (at least 1 which shouldn't be ignored) , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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