These 4 Measures Indicate That Sunty Development (TWSE:3266) Is Using Debt Extensively

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Sunty Development Co., LTD (TWSE:3266) makes use of debt. But the real question is whether this debt is making the company risky.

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 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Sunty Development

What Is Sunty Development's Debt?

The image below, which you can click on for greater detail, shows that Sunty Development had debt of NT$3.74b at the end of June 2024, a reduction from NT$5.16b over a year. However, it also had NT$1.17b in cash, and so its net debt is NT$2.57b.

How Strong Is Sunty Development's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sunty Development had liabilities of NT$6.84b due within 12 months and liabilities of NT$346.7m due beyond that. On the other hand, it had cash of NT$1.17b and NT$63.3m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$5.95b.

This is a mountain of leverage relative to its market capitalization of NT$6.91b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Sunty Development's net debt is 2.8 times its EBITDA, which is a significant but still reasonable amount of leverage. However, its interest coverage of 1k is very high, suggesting that the interest expense on the debt is currently quite low. Pleasingly, Sunty Development is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 2,786% gain in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is Sunty Development's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Sunty Development reported free cash flow worth 9.8% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

Even if we have reservations about how easily Sunty Development is capable of converting EBIT to free cash flow, its interest cover and EBIT growth rate make us think feel relatively unconcerned. We think that Sunty Development's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. To that end, you should be aware of the 2 warning signs we've spotted with Sunty Development .

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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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.