Sunty Development (TWSE:3266) Takes On Some Risk With Its Use Of Debt

Warren Buffett famously said, '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 Sunty Development Co., LTD (TWSE:3266) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Sunty Development

What Is Sunty Development's Debt?

As you can see below, Sunty Development had NT$4.61b of debt at September 2023, down from NT$5.04b a year prior. However, because it has a cash reserve of NT$1.19b, its net debt is less, at about NT$3.41b.

How Strong Is Sunty Development's Balance Sheet?

We can see from the most recent balance sheet that Sunty Development had liabilities of NT$7.68b falling due within a year, and liabilities of NT$352.4m due beyond that. Offsetting this, it had NT$1.19b in cash and NT$85.3m in receivables that were due within 12 months. So it has liabilities totalling NT$6.75b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of NT$7.57b, so it does suggest shareholders should keep an eye on Sunty Development's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Strangely Sunty Development has a sky high EBITDA ratio of 6.4, implying high debt, but a strong interest coverage of 30.5. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Pleasingly, Sunty Development is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 1,326% gain in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Sunty Development 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 company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Sunty Development burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

While Sunty Development's conversion of EBIT to free cash flow has us nervous. To wit both its interest cover and EBIT growth rate were encouraging signs. Taking the abovementioned factors together we do think Sunty Development's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 3 warning signs we've spotted with Sunty Development .

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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.