Is Shine Justice (ASX:SHJ) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Shine Justice Ltd (ASX:SHJ) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Shine Justice

What Is Shine Justice's Debt?

As you can see below, Shine Justice had AU$46.1m of debt, at December 2020, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has AU$49.5m in cash, leading to a AU$3.44m net cash position.

A Look At Shine Justice's Liabilities

Zooming in on the latest balance sheet data, we can see that Shine Justice had liabilities of AU$121.0m due within 12 months and liabilities of AU$185.6m due beyond that. Offsetting this, it had AU$49.5m in cash and AU$242.6m in receivables that were due within 12 months. So its liabilities total AU$14.5m more than the combination of its cash and short-term receivables.

Given Shine Justice has a market capitalization of AU$183.7m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Shine Justice boasts net cash, so it's fair to say it does not have a heavy debt load!

One way Shine Justice could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 11%, as it did over the last year. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Shine Justice's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Shine Justice may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Shine Justice produced sturdy free cash flow equating to 72% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Shine Justice has AU$3.44m in net cash. The cherry on top was that in converted 72% of that EBIT to free cash flow, bringing in AU$46m. So we don't think Shine Justice's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Shine Justice that you should be aware of.

At the end of the day, it's 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). It's 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.
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