David Iben put it well when he said, “Volatility is not a risk we care about. What matters to us is to avoid the permanent loss of capital. ‘ So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. We can see that Sunex SA (WSE: SNX) uses debt in its business. But does this debt worry shareholders?
When Is Debt a Problem?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then 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) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. When we look at debt levels, we first consider both cash and debt levels.
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What is Sunex’s net debt?
You can click on the graph below for the historical numbers, but it shows that in March 2021 Sunex had a debt of Z 9.16million, an increase from Z 8.14million, on a year. However, he has 761.1000 z in cash to compensate for this, resulting in net debt of about 8.39 million z.
Is Sunex’s Balance Sheet Healthy?
According to the latest published balance sheet, Sunex had a liability of Z36.0 million due within 12 months and a liability of Z 16.0 million due beyond 12 months. On the other hand, he had cash of Z 761.1,000 and Z 24.7 million of receivables due within one year. Thus, its liabilities exceed the sum of its cash and (short-term) receivables by Z 26.5 million.
While that might sound like a lot, it’s not that bad since Sunex has a market cap of Z129.7million, and could therefore likely strengthen its balance sheet by raising capital if needed. But we absolutely want to keep our eyes open for indications that its debt is too risky.
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 ) covers its interests. costs (interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
Sunex has a low net debt to EBITDA ratio of just 0.64. And its EBIT covers its interest costs a whopping 36.3 times. So we’re pretty relaxed about its ultra-conservative use of debt. Even more impressively, Sunex increased its EBIT by 104% year over year. This boost will make it even easier to pay down debt in the future. When analyzing debt levels, the balance sheet is the obvious starting point. But it is Sunex’s results that will influence the balance sheet in the future. So, when considering debt, it is really worth looking at the profit trend. Click here for an interactive snapshot.
Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Sunex has spent a lot of money. While this may be the result of spending on growth, it makes debt much riskier.
Our point of view
Fortunately, Sunex’s impressive interest coverage means it has the upper hand on its debt. But the hard truth is that we are concerned about its conversion from EBIT to free cash flow. All these things considered, it looks like Sunex can comfortably manage its current debt levels. Of course, while this leverage can improve returns on equity, it comes with more risk, so it’s worth keeping an eye out for. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks lie on the balance sheet – far from it. For example, we discovered 2 warning signs for Sunex (1 is concerning!) Which you should know before investing here.
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
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