Sweeten Real Estate DevelopmentLtd (TPE:5525) Seems To Be Using A Lot Of Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Sweeten Real Estate Development Co.,Ltd. (TPE:5525) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, 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.

View our latest analysis for Sweeten Real Estate DevelopmentLtd

What Is Sweeten Real Estate DevelopmentLtd's Net Debt?

As you can see below, at the end of September 2020, Sweeten Real Estate DevelopmentLtd had NT$5.22b of debt, up from NT$4.76b a year ago. Click the image for more detail. However, because it has a cash reserve of NT$289.6m, its net debt is less, at about NT$4.93b.

A Look At Sweeten Real Estate DevelopmentLtd's Liabilities

Zooming in on the latest balance sheet data, we can see that Sweeten Real Estate DevelopmentLtd had liabilities of NT$7.60b due within 12 months and liabilities of NT$553.4m due beyond that. Offsetting these obligations, it had cash of NT$289.6m as well as receivables valued at NT$383.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$7.48b.

Given this deficit is actually higher than the company's market capitalization of NT$5.48b, we think shareholders really should watch Sweeten Real Estate DevelopmentLtd's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With a net debt to EBITDA ratio of 30.8, it's fair to say Sweeten Real Estate DevelopmentLtd does have a significant amount of debt. But the good news is that it boasts fairly comforting interest cover of 4.7 times, suggesting it can responsibly service its obligations. Shareholders should be aware that Sweeten Real Estate DevelopmentLtd's EBIT was down 80% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 Sweeten Real Estate DevelopmentLtd 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Sweeten Real Estate 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, Sweeten Real Estate 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 its interest cover is not so bad. We think the chances that Sweeten Real Estate DevelopmentLtd has too much debt a very significant. To our minds, that means the stock is rather high risk, and probably one to avoid; but to each their own (investing) style. 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. Be aware that Sweeten Real Estate DevelopmentLtd is showing 2 warning signs in our investment analysis , and 1 of those can't be ignored...

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.

If you decide to trade Sweeten Real Estate DevelopmentLtd, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted

This article by Simply Wall St is general in nature. 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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.