Sunnic Technology & Merchandise (GTSM:3360) Seems To Be Using A Lot Of Debt

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. We note that Sunnic Technology & Merchandise Inc (GTSM:3360) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. 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 Sunnic Technology & Merchandise

What Is Sunnic Technology & Merchandise's Net Debt?

The chart below, which you can click on for greater detail, shows that Sunnic Technology & Merchandise had NT$2.30b in debt in September 2020; about the same as the year before. On the flip side, it has NT$394.0m in cash leading to net debt of about NT$1.91b.

How Healthy Is Sunnic Technology & Merchandise's Balance Sheet?

According to the last reported balance sheet, Sunnic Technology & Merchandise had liabilities of NT$4.15b due within 12 months, and liabilities of NT$42.6m due beyond 12 months. Offsetting these obligations, it had cash of NT$394.0m as well as receivables valued at NT$3.16b due within 12 months. So its liabilities total NT$636.5m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of NT$1.02b, so it does suggest shareholders should keep an eye on Sunnic Technology & Merchandise's use of debt. 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Sunnic Technology & Merchandise has a rather high debt to EBITDA ratio of 10.0 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 2.7 times, suggesting it can responsibly service its obligations. Investors should also be troubled by the fact that Sunnic Technology & Merchandise saw its EBIT drop by 20% over the last twelve months. If things keep going like that, handling the debt will about as easy as bundling an angry house cat into its travel box. There's no doubt that we learn most about debt from the balance sheet. But it is Sunnic Technology & Merchandise'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, 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, Sunnic Technology & Merchandise 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

To be frank both Sunnic Technology & Merchandise's net debt to EBITDA and its track record of converting EBIT to free cash flow make us rather uncomfortable with its debt levels. And even its interest cover fails to inspire much confidence. Taking into account all the aforementioned factors, it looks like Sunnic Technology & Merchandise has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 3 warning signs we've spotted with Sunnic Technology & Merchandise (including 2 which are significant) .

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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