These 4 Measures Indicate That Sincere Navigation (TPE:2605) Is Using Debt Safely

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. As with many other companies Sincere Navigation Corporation (TPE:2605) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Sincere Navigation

What Is Sincere Navigation's Debt?

As you can see below, Sincere Navigation had NT$4.58b of debt at September 2020, down from NT$6.48b a year prior. On the flip side, it has NT$4.40b in cash leading to net debt of about NT$176.5m.

A Look At Sincere Navigation's Liabilities

According to the last reported balance sheet, Sincere Navigation had liabilities of NT$2.05b due within 12 months, and liabilities of NT$3.70b due beyond 12 months. On the other hand, it had cash of NT$4.40b and NT$525.7m worth of receivables due within a year. So its liabilities total NT$827.1m more than the combination of its cash and short-term receivables.

Given Sincere Navigation has a market capitalization of NT$9.22b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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.

Sincere Navigation's net debt to EBITDA ratio is very low, at 0.076, suggesting the debt is only trivial. Although with EBIT only covering interest expenses 6.1 times over, the company is truly paying for borrowing. Better yet, Sincere Navigation grew its EBIT by 638% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Sincere Navigation's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Sincere Navigation 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

Happily, Sincere Navigation's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. And the good news does not stop there, as its EBIT growth rate also supports that impression! Overall, we don't think Sincere Navigation is taking any bad risks, as its debt load seems modest. So we're not worried about the use of a little leverage on the balance sheet. 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. Be aware that Sincere Navigation is showing 2 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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