Is Sampo (TPE:1604) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We can see that Sampo Corporation (TPE:1604) does use debt in its business. But should shareholders be worried about its use of debt?

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. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Sampo

How Much Debt Does Sampo Carry?

The image below, which you can click on for greater detail, shows that Sampo had debt of NT$900.0m at the end of December 2020, a reduction from NT$2.17b over a year. But on the other hand it also has NT$1.16b in cash, leading to a NT$256.1m net cash position.

A Look At Sampo's Liabilities

According to the last reported balance sheet, Sampo had liabilities of NT$2.01b due within 12 months, and liabilities of NT$2.51b due beyond 12 months. Offsetting these obligations, it had cash of NT$1.16b as well as receivables valued at NT$586.8m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$2.78b.

While this might seem like a lot, it is not so bad since Sampo has a market capitalization of NT$11.3b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Sampo boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Sampo grew its EBIT by 77% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Sampo's earnings that will influence how the balance sheet holds up in the future. 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 company can only pay off debt with cold hard cash, not accounting profits. While Sampo has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Sampo saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

While Sampo does have more liabilities than liquid assets, it also has net cash of NT$256.1m. And we liked the look of last year's 77% year-on-year EBIT growth. So we don't have any problem with Sampo's use of 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. For example Sampo has 2 warning signs (and 1 which shouldn't be ignored) we think you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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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