Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that Volatility is far from synonymous with risk. Its only natural to consider a companys balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Sea & Land Integrated Corp. (GTSM:5603) does use debt in its business. But should shareholders be worried about its use of debt?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Sea & Land Integrated

You can click the graphic below for the historical numbers, but it shows that as of March 2020 Sea & Land Integrated had NT$735.2m of debt, an increase on NT$518.1m, over one year. However, it does have NT$144.9m in cash offsetting this, leading to net debt of about NT$590.3m.

We can see from the most recent balance sheet that Sea & Land Integrated had liabilities of NT$639.4m falling due within a year, and liabilities of NT$541.2m due beyond that. Offsetting this, it had NT$144.9m in cash and NT$385.2m in receivables that were due within 12 months. So its liabilities total NT$650.4m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of NT$838.1m, so it does suggest shareholders should keep an eye on Sea & Land Integrateds use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

We measure a companys debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 0.87 times and a disturbingly high net debt to EBITDA ratio of 5.7 hit our confidence in Sea & Land Integrated like a one-two punch to the gut. This means wed consider it to have a heavy debt load. However, the silver lining was that Sea & Land Integrated achieved a positive EBIT of NT$4.7m in the last twelve months, an improvement on the prior years loss. When analysing debt levels, the balance sheet is the obvious place to start. But you cant view debt in total isolation; since Sea & Land Integrated will need earnings to service that debt. So if youre keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just dont cut it. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, Sea & Land Integrated burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

On the face of it, Sea & Land Integrateds interest cover left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But at least its EBIT growth rate is not so bad. Overall, it seems to us that Sea & Land Integrateds balance sheet is really quite a risk to the business. So were almost as wary of this stock as a hungry kitten is about falling into its owners fish pond: once bitten, twice shy, as they say. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet far from it. For example, weve discovered 3 warning signs for Sea & Land Integrated (2 are a bit concerning!) that you should be aware of before investing here.

At the end of the day, its often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). Its free.

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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. *Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

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These 4 Measures Indicate That Sea & Land Integrated (GTSM:5603) Is Using Debt Extensively - Simply Wall St