Is Seazen Group (HKG:1030) a risky investment?
Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. We note that Seazen Group Limited (HKG:1030) has a debt on its balance sheet. But the more important question is: what risk does this debt create?
When is debt dangerous?
Generally speaking, debt only becomes a real problem when a company cannot easily repay it, either by raising capital or with its own cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.
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What is the debt of the Seazen group?
The image below, which you can click on for more details, shows that the Seazen Group had a debt of 92.7 billion Canadian yen at the end of June 2022, a reduction from 114.4 billion yen Canadians over one year. However, he also had 40.6 billion Canadian yen in cash, so his net debt is 52.1 billion domestic yen.
How healthy is the Seazen group’s balance sheet?
The latest balance sheet data shows that Seazen Group had liabilities of 353.8 billion yen maturing within one year, and liabilities of 68.6 billion yen maturing thereafter. On the other hand, it had a cash position of 40.6 billion Canadian yen and 68.8 billion national yen of receivables due within one year. It therefore has liabilities totaling 312.9 billion Canadian yen more than its cash and short-term receivables, combined.
This deficit casts a shadow over the CN¥9.60b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Seazen Group would likely need a major recapitalization if it were to pay its creditors today.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
Seazen Group has a debt to EBITDA ratio of 3.6, which signals significant debt, but is still quite reasonable for most types of businesses. But its EBIT was around 23.8 times its interest expense, implying that the company isn’t really paying a high cost to maintain that level of leverage. Even if the low cost turns out to be unsustainable, that’s a good sign. Importantly, Seazen Group’s EBIT has fallen by 46% over the last twelve months. If this decline continues, it will be more difficult to repay debts than to sell foie gras at a vegan convention. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether Seazen Group can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a company can only repay its debts with cold hard cash, not with book profits. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, Seazen Group has actually produced more free cash flow than EBIT. There’s nothing better than incoming money to stay in the good books of your lenders.
Our point of view
At first glance, Seazen Group’s EBIT growth rate left us hesitant about the stock, and its level of total liabilities was no more appealing than the single empty restaurant on the busiest night of the year. But at least it’s decent enough to cover its interest costs with its EBIT; it’s encouraging. Overall, we think it’s fair to say that the Seazen Group has enough debt that there are real risks around the balance sheet. If all goes well, this should boost returns, but on the other hand, the risk of permanent capital loss is increased by debt. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. These risks can be difficult to spot. Every business has them, and we’ve spotted 4 warning signs for Seazen Group (1 of which can’t be ignored!) that you should know about.
In the end, it’s often best to focus on companies that aren’t in debt. You can access our special list of these companies (all with a track record of earnings growth). It’s free.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.