These 4 Measures Indicate That Shi Shi Services (HKG:8181) Is Using Debt Reasonably Well

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. Importantly, Shi Shi Services Limited (HKG:8181) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Shi Shi Services

How Much Debt Does Shi Shi Services Carry?

The chart below, which you can click on for greater detail, shows that Shi Shi Services had HK$18.7m in debt in March 2021; about the same as the year before. But it also has HK$107.6m in cash to offset that, meaning it has HK$88.9m net cash.

How Strong Is Shi Shi Services' Balance Sheet?

According to the last reported balance sheet, Shi Shi Services had liabilities of HK$94.5m due within 12 months, and liabilities of HK$9.18m due beyond 12 months. Offsetting these obligations, it had cash of HK$107.6m as well as receivables valued at HK$140.4m due within 12 months. So it actually has HK$144.3m more liquid assets than total liabilities.

This luscious liquidity implies that Shi Shi Services' balance sheet is sturdy like a giant sequoia tree. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Shi Shi Services has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Shi Shi Services's saving grace is its low debt levels, because its EBIT has tanked 51% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Shi Shi Services's earnings that will influence how the balance sheet holds up in the future. So if you're 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 don't cut it. Shi Shi Services 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. Over the last three years, Shi Shi Services recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Shi Shi Services has net cash of HK$88.9m, as well as more liquid assets than liabilities. So we don't have any problem with Shi Shi Services's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Shi Shi Services that you should be aware of before investing here.

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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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