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 Samwha Electronics Co.,Ltd. (KRX:011230) makes use of 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. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company’s debt levels is to consider its cash and debt together.
How Much Debt Does Samwha ElectronicsLtd Carry?
The image below, which you can click on for greater detail, shows that Samwha ElectronicsLtd had debt of ₩20.0b at the end of December 2019, a reduction from ₩21.3b over a year. However, it does have ₩1.00b in cash offsetting this, leading to net debt of about ₩19.0b.
A Look At Samwha ElectronicsLtd’s Liabilities
We can see from the most recent balance sheet that Samwha ElectronicsLtd had liabilities of ₩32.7b falling due within a year, and liabilities of ₩11.6b due beyond that. Offsetting these obligations, it had cash of ₩1.00b as well as receivables valued at ₩7.86b due within 12 months. So its liabilities total ₩35.4b more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the ₩20.3b company, like a colossus towering over mere mortals. So we’d watch its balance sheet closely, without a doubt. After all, Samwha ElectronicsLtd would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But it is Samwha ElectronicsLtd’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.
In the last year Samwha ElectronicsLtd’s revenue was pretty flat, and it made a negative EBIT. While that’s not too bad, we’d prefer see growth.
Importantly, Samwha ElectronicsLtd had negative earnings before interest and tax (EBIT), over the last year. Indeed, it lost ₩221m at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through ₩4.1b in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. 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. Consider for instance, the ever-present spectre of investment risk. We’ve identified 6 warning signs with Samwha ElectronicsLtd (at least 3 which are a bit unpleasant) , and understanding them should be part of your investment process.
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 spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.
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