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 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 can see that Samebest Co., Ltd. (GTSM:8489) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
Check out our latest analysis for Samebest
How Much Debt Does Samebest Carry?
The image below, which you can click on for greater detail, shows that at June 2020 Samebest had debt of NT$81.7m, up from none in one year. But it also has NT$1.07b in cash to offset that, meaning it has NT$988.4m net cash.
How Healthy Is Samebest's Balance Sheet?
We can see from the most recent balance sheet that Samebest had liabilities of NT$709.9m falling due within a year, and liabilities of NT$190.3m due beyond that. Offsetting this, it had NT$1.07b in cash and NT$125.6m in receivables that were due within 12 months. So it actually has NT$295.6m more liquid assets than total liabilities.
This surplus suggests that Samebest has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Samebest boasts net cash, so it's fair to say it does not have a heavy debt load!
It is just as well that Samebest's load is not too heavy, because its EBIT was down 59% 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 you can't view debt in total isolation; since Samebest 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. 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. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
Summing up
While it is always sensible to investigate a company's debt, in this case Samebest has NT$988.4m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of NT$204m, being 115% of its EBIT. So we don't have any problem with Samebest'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 instance, we've identified 3 warning signs for Samebest that 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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