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 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. We note that Samebest Co., Ltd. (GTSM:8489) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Samebest Carry?
The image below, which you can click on for greater detail, shows that Samebest had debt of NT$80.8m at the end of September 2020, a reduction from NT$84.4m over a year. But it also has NT$962.6m in cash to offset that, meaning it has NT$881.8m net cash.
How Strong Is Samebest's Balance Sheet?
We can see from the most recent balance sheet that Samebest had liabilities of NT$583.4m falling due within a year, and liabilities of NT$194.1m due beyond that. Offsetting these obligations, it had cash of NT$962.6m as well as receivables valued at NT$147.2m due within 12 months. So it actually has NT$332.3m more liquid assets than total liabilities.
This surplus suggests that Samebest is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Samebest has more cash than debt is arguably a good indication that it can manage its debt safely.
In fact Samebest's saving grace is its low debt levels, because its EBIT has tanked 50% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But it is Samebest'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. Samebest 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, Samebest actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
While it is always sensible to investigate a company's debt, in this case Samebest has NT$881.8m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 101% of that EBIT to free cash flow, bringing in NT$176m. So is Samebest's debt a risk? It doesn't seem so to us. 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. Take risks, for example - Samebest has 4 warning signs we think you should be aware of.
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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