Here's Why Sunfun Info (GTSM:5278) Can Manage Its Debt Responsibly

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.' 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 note that Sunfun Info Co., Ltd. (GTSM:5278) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

Check out our latest analysis for Sunfun Info

What Is Sunfun Info's Net Debt?

As you can see below, Sunfun Info had NT$65.6m of debt at September 2020, down from NT$76.2m a year prior. However, its balance sheet shows it holds NT$512.8m in cash, so it actually has NT$447.2m net cash.

A Look At Sunfun Info's Liabilities

Zooming in on the latest balance sheet data, we can see that Sunfun Info had liabilities of NT$234.2m due within 12 months and liabilities of NT$48.7m due beyond that. On the other hand, it had cash of NT$512.8m and NT$81.5m worth of receivables due within a year. So it can boast NT$311.4m more liquid assets than total liabilities.

This surplus suggests that Sunfun Info has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Sunfun Info has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that Sunfun Info's load is not too heavy, because its EBIT was down 26% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But it is Sunfun Info'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Sunfun Info 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, Sunfun Info recorded free cash flow worth a fulsome 86% 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

While we empathize with investors who find debt concerning, you should keep in mind that Sunfun Info has net cash of NT$447.2m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of NT$187m, being 86% of its EBIT. So we are not troubled with Sunfun Info's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Sunfun Info is showing 3 warning signs in our investment analysis , you should know about...

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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