Stock Analysis

Sakura DevelopmentLtd (TPE:2539) Has A Somewhat Strained Balance Sheet

TWSE:2539
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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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Sakura Development Co.,Ltd (TPE:2539) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Sakura DevelopmentLtd

What Is Sakura DevelopmentLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Sakura DevelopmentLtd had NT$8.09b of debt, an increase on NT$4.70b, over one year. Net debt is about the same, since the it doesn't have much cash.

debt-equity-history-analysis
TSEC:2539 Debt to Equity History April 22nd 2021

How Healthy Is Sakura DevelopmentLtd's Balance Sheet?

We can see from the most recent balance sheet that Sakura DevelopmentLtd had liabilities of NT$6.80b falling due within a year, and liabilities of NT$3.57b due beyond that. Offsetting this, it had NT$155.5m in cash and NT$43.9m in receivables that were due within 12 months. So its liabilities total NT$10.2b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Sakura DevelopmentLtd is worth NT$18.4b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Strangely Sakura DevelopmentLtd has a sky high EBITDA ratio of 7.5, implying high debt, but a strong interest coverage of 57.1. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. Importantly, Sakura DevelopmentLtd's EBIT fell a jaw-dropping 36% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But it is Sakura DevelopmentLtd'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Sakura DevelopmentLtd saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Sakura DevelopmentLtd's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. We're quite clear that we consider Sakura DevelopmentLtd to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. 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 example, we've discovered 2 warning signs for Sakura DevelopmentLtd that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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