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 risk.” 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. Above all, Synex International Inc. (TSE: SXI) is in debt. But the real question is whether this debt makes the business risky.
What risk does debt entail?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. Of course, many companies use debt to finance their growth without 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 Synex International
What is Synex International’s net debt?
The image below, which you can click for more details, shows that Synex International had a debt of C $ 12.8 million at the end of March 2021, a reduction from $ 13.7 million. Canadians over one year. And he doesn’t have a lot of cash, so his net debt is about the same.
Is Synex International’s balance sheet healthy?
We can see from the most recent balance sheet that Synex International had liabilities of C $ 11.1 million maturing within one year and liabilities of C $ 3.57 million maturing within one year. -of the. On the other hand, she had cash of C $ 125,000 and C $ 647.6,000 of receivables due within one year. Its liabilities therefore total C $ 13.9 million more than the combination of its cash and short-term receivables.
When you consider that this deficit exceeds the company’s C $ 12.3 million market capitalization, you may well be inclined to take a close look at the balance sheet. In the scenario where the company had to clean up its balance sheet quickly, it seems likely that shareholders would suffer a significant dilution.
We measure a company’s debt load relative to its earning capacity by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT) covers its interest costs (interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Synex International shareholders are faced with the double whammy of a high net debt to EBITDA ratio (9.4) and relatively low interest coverage, since EBIT is only 0.60 times expenses of interest. This means that we would consider him to be in heavy debt. A buyout factor for Synex International is that it turned last year’s loss of EBIT into a gain of C $ 343,000 over the past twelve months. When analyzing debt levels, the balance sheet is the obvious starting point. But it is the results of Synex International that will influence the performance of 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.
But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. It is therefore worth checking to what extent earnings before interest and taxes (EBIT) are backed by free cash flow. Over the past year, Synex International generated strong free cash flow equivalent to 62% of its EBIT, roughly what we expected. This free cash flow puts the business in a good position to repay debt, if any.
Our point of view
At first glance, Synex International’s net debt to EBITDA left us hesitant about the stock, and its interest hedging was no more attractive than the only restaurant empty on the busiest night of the year. But on the positive side, its conversion from EBIT to free cash flow is a good sign and makes us more optimistic. Looking at the big picture, it seems clear to us that Synex International’s use of debt creates risks for the company. If all goes well, this should increase returns, but on the other hand, the risk of permanent capital loss is increased by debt. The balance sheet is clearly the area you need to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist off the balance sheet. To this end, you should inquire about the 3 warning signs we spotted with Synex International (including 2 which are a bit rude).
If you are interested in investing in companies that can generate profits without the burden of debt, check out this page free list of growing companies that have net cash on the balance sheet.
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