Warren Buffett said: “Volatility is far from synonymous with risk”. So it can be obvious that you need to consider debt, when you think about how risky a given stock is, because too much debt can sink a business. We note that CammSys Corp. (KOSDAQ: 050110) has a debt on its balance sheet. But the most important question is: what risk does this debt create?
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. If things really go wrong, lenders can take over the business. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. 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. When we look at debt levels, we first look at cash and debt levels together.
What is CammSys debt?
The image below, which you can click for more details, shows that as of September 2020, CammSys had a debt of 123.1 billion yen, up from 82.8 billion yen in a year. On the other hand, he has 80.4 billion yen in cash, resulting in net debt of around 42.7 billion yen.
A look at the responsibilities of CammSys
Zooming in on the latest balance sheet data, we can see that CammSys had a liability of 237.8 billion yen due within 12 months and a liability of 23.6 billion yen beyond. On the other hand, he had 80.4 billion yen in cash and 97.4 billion yen in receivables due within one year. Its liabilities are therefore 83.6 billion euros more than the combination of its cash and short-term receivables.
While that might sound like a lot, it’s not that bad since CammSys has a market cap of 185.0 billion yen, and therefore could likely strengthen its balance sheet by raising capital if needed. But it is clear that it is absolutely necessary to take a close look at whether it can manage its debt without dilution.
We use two main ratios to inform us about the levels of debt compared to earnings. The first is net debt divided by earnings before interest, taxes, depreciation, and amortization (EBITDA), while the second is the number of times its profit before interest and taxes (EBIT) covers its interest expense (or its coverage of interest, for short). 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).
While CammSys has a very reasonable net debt to EBITDA ratio of 1.7, its interest coverage appears low at 0.49. A lot of it is that there is so much depreciation and amortization. These charges can be non-monetary, so they could be excluded when it comes to paying off debt. But the accounting fees are there for a reason: some assets lose value. Either way, there’s no doubt that the stock uses significant leverage. Shareholders should know that CammSys EBIT fell 93% last year. If this decline continues, then it will be more difficult to pay off the debt than to sell foie gras at a vegan convention. The balance sheet is clearly the area to focus on when analyzing debt. But it is the profits of CammSys that will influence the balance sheet in the future. So if you want to know more about his earnings, it might be worth checking out this graph of his long-term profit trend.
Finally, while the IRS may love accounting profits, lenders only accept hard cash. We must therefore clearly check whether this EBIT generates a corresponding free cash flow. Over the past three years CammSys has spent a lot of money. While investors no doubt expect this situation to reverse in due course, it clearly means that its use of debt is riskier.
Our point of view
To be frank, CammSys’ EBIT conversion to free cash flow and its history of (non) growth in its EBIT make us rather uncomfortable with its debt levels. But at least his net debt to EBITDA isn’t that bad. We’re pretty clear that we consider CammSys to be really quite risky, due to the health of its balance sheet. We are therefore almost as wary of this stock as a hungry kitten falls into its owner’s fish pond: once bitten, twice shy, as they say. 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. We have identified 2 warning signs with CammSys (at least 1 which should not be ignored) , and understanding them should be part of your investment process.
Of course, if you are the kind of investor who prefers to buy stocks without going into debt, then feel free to find out. our exclusive list of cash net growth stocks, today.
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