These 4 Measures Indicate That Sunfon Construction (GTSM:5514) Is Using Debt Reasonably Well

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 Sunfon Construction Co., Ltd. (GTSM:5514) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Sunfon Construction

What Is Sunfon Construction's Net Debt?

As you can see below, Sunfon Construction had NT$363.2m of debt at December 2020, down from NT$482.5m a year prior. But it also has NT$482.3m in cash to offset that, meaning it has NT$119.1m net cash.

How Healthy Is Sunfon Construction's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Sunfon Construction had liabilities of NT$575.2m due within 12 months and liabilities of NT$11.0m due beyond that. Offsetting this, it had NT$482.3m in cash and NT$1.03m in receivables that were due within 12 months. So its liabilities total NT$102.8m more than the combination of its cash and short-term receivables.

Of course, Sunfon Construction has a market capitalization of NT$3.77b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Sunfon Construction also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is just as well that Sunfon Construction's load is not too heavy, because its EBIT was down 44% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Sunfon Construction will need earnings to service that debt. 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. While Sunfon Construction 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. Happily for any shareholders, Sunfon Construction actually produced more free cash flow than EBIT over the last two years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

We could understand if investors are concerned about Sunfon Construction's liabilities, but we can be reassured by the fact it has has net cash of NT$119.1m. And it impressed us with free cash flow of -NT$61m, being 117% of its EBIT. So we are not troubled with Sunfon Construction'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. For instance, we've identified 1 warning sign for Sunfon Construction that 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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