Here's Why Sea & Land Integrated (GTSM:5603) Can Manage Its Debt Responsibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We can see that Sea & Land Integrated Corp. (GTSM:5603) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. 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 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 Sea & Land Integrated

How Much Debt Does Sea & Land Integrated Carry?

The chart below, which you can click on for greater detail, shows that Sea & Land Integrated had NT$690.4m in debt in September 2020; about the same as the year before. However, it also had NT$125.2m in cash, and so its net debt is NT$565.1m.

A Look At Sea & Land Integrated's Liabilities

According to the last reported balance sheet, Sea & Land Integrated had liabilities of NT$732.4m due within 12 months, and liabilities of NT$491.7m due beyond 12 months. Offsetting these obligations, it had cash of NT$125.2m as well as receivables valued at NT$478.6m due within 12 months. So its liabilities total NT$620.3m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Sea & Land Integrated is worth NT$1.62b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

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.

Sea & Land Integrated has net debt to EBITDA of 3.7 suggesting it uses a fair bit of leverage to boost returns. On the plus side, its EBIT was 9.6 times its interest expense, and its net debt to EBITDA, was quite high, at 3.7. Notably, Sea & Land Integrated made a loss at the EBIT level, last year, but improved that to positive EBIT of NT$52m in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Sea & Land Integrated 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, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, Sea & Land Integrated actually produced more free cash flow than EBIT over the last year. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

On our analysis Sea & Land Integrated's conversion of EBIT to free cash flow should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For example, its net debt to EBITDA makes us a little nervous about its debt. Considering this range of data points, we think Sea & Land Integrated is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 5 warning signs for Sea & Land Integrated (2 shouldn't be ignored) you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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