Howard Marks put it right when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk that concerns me … and every investor I practice. know worries. It is natural to consider a company’s balance sheet when considering how risky it is, as debt is often involved when a business collapses. We notice that Samsung Electro-Mechanics Co., Ltd. (KRX: 009150) has debt on its balance sheet. But does this debt worry shareholders?
Why is debt risky?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap stock price just to get its debt under control. Of course, many companies use debt to finance growth without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash flow and debt together.
Check out our latest review for Samsung Electro-Mechanics
What is the debt borne by Samsung Electro-Mechanics?
As you can see below, Samsung Electro-Mechanics had 1.84t of debt in December 2020, up from 1.96t the year before. On the other hand, it has 1.48 t of cash, which leads to a net debt of around 364.3 billion.
How strong is Samsung Electro-Mechanics’ balance sheet?
We can see from the most recent balance sheet that Samsung Electro-Mechanics had liabilities of 1.91 t due within one year and debts of 1.40 t. Beyond. On the other hand, it had cash of 1.48 t and ₩ 996.5 billion in receivables due within one year. Thus, its liabilities outweigh the sum of its cash and its (short-term) receivables by ₩ 838.9 billion.
Of course, Samsung Electro-Mechanics has a titanic market cap of 15t, so those liabilities are probably manageable. Having said that, it is clear that we must continue to monitor his record lest it get worse.
We measure a company’s indebtedness relative to its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating the ease with which its earnings before interest and taxes (EBIT ) cover his interests. costs (interest coverage). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt over EBITDA) and the actual interest charges associated with that debt (with its interest coverage ratio).
Samsung Electro-Mechanics has a low net debt to EBITDA ratio of just 0.22. And its EBIT covers its interest costs 22.3 times more. We could therefore say that he is no more threatened by his debt than an elephant is by a mouse. And we also warmly note that Samsung Electro-Mechanics increased its EBIT by 12% last year, making its debt more manageable. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Samsung Electro-Mechanics can strengthen its balance sheet over time. So if you are focused on the future you can check out this free report showing analysts’ earnings forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits do not reduce it. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, Samsung Electro-Mechanics’ free cash flow has been 23% of its EBIT, less than we expected. This low cash conversion makes debt management more difficult.
Our point of view
The good news is that Samsung Electro-Mechanics’ demonstrated ability to cover its interest costs with its EBIT delights us like a fluffy puppy does with a toddler. But frankly, we think his conversion from EBIT to free cash flow undermines that impression a bit. When we consider the range of factors above, it looks like Samsung Electro-Mechanics is pretty reasonable with its use of debt. This means that they are taking a bit more risk, in the hope of increasing returns for shareholders. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, we discovered 1 warning sign for Samsung Electro-Mechanics which you should be aware of before investing here.
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
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