Is Sea & Land Integrated (GTSM:5603) A Risky Investment?

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.' 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 the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Sea & Land Integrated

How Much Debt Does Sea & Land Integrated Carry?

The image below, which you can click on for greater detail, shows that Sea & Land Integrated had debt of NT$540.4m at the end of December 2020, a reduction from NT$665.3m over a year. However, because it has a cash reserve of NT$213.5m, its net debt is less, at about NT$326.9m.

A Look At Sea & Land Integrated's Liabilities

The latest balance sheet data shows that Sea & Land Integrated had liabilities of NT$631.3m due within a year, and liabilities of NT$406.9m falling due after that. Offsetting these obligations, it had cash of NT$213.5m as well as receivables valued at NT$400.6m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$424.1m.

While this might seem like a lot, it is not so bad since Sea & Land Integrated has a market capitalization of NT$1.66b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Sea & Land Integrated has net debt worth 2.0 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 6.0 times the interest expense. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. Notably, Sea & Land Integrated made a loss at the EBIT level, last year, but improved that to positive EBIT of NT$58m in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Sea & Land Integrated's earnings that will influence how the balance sheet holds up in the future. 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. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Sea & Land Integrated actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

The good news is that Sea & Land Integrated's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. And its interest cover is good too. Looking at all the aforementioned factors together, it strikes us that Sea & Land Integrated can handle its debt fairly comfortably. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. 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 Sea & Land Integrated is showing 4 warning signs in our investment analysis , and 1 of those is a bit unpleasant...

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.

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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.
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