Is Shin Hwa World (HKG:582) Using Debt In A Risky Way?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Shin Hwa World Limited (HKG:582) does have debt on its balance sheet. But is this debt a concern to shareholders?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Shin Hwa World

What Is Shin Hwa World's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Shin Hwa World had HK$1.48b of debt in June 2023, down from HK$1.58b, one year before. On the flip side, it has HK$313.9m in cash leading to net debt of about HK$1.17b.

A Look At Shin Hwa World's Liabilities

According to the last reported balance sheet, Shin Hwa World had liabilities of HK$411.3m due within 12 months, and liabilities of HK$1.50b due beyond 12 months. Offsetting this, it had HK$313.9m in cash and HK$13.0k in receivables that were due within 12 months. So its liabilities total HK$1.60b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the HK$211.3m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Shin Hwa World would probably need a major re-capitalization if its creditors were to demand repayment. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Shin Hwa World will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

In the last year Shin Hwa World had a loss before interest and tax, and actually shrunk its revenue by 29%, to HK$1.1b. That makes us nervous, to say the least.

Caveat Emptor

While Shin Hwa World's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable HK$427m at the EBIT level. Reflecting on this and the significant total liabilities, it's hard to know what to say about the stock because of our intense dis-affinity for it. Sure, the company might have a nice story about how they are going on to a brighter future. But the fact is that it incinerated HK$103m of cash in the last twelve months, and has precious few liquid assets in comparison to its liabilities. So we consider this a high risk stock, and we're worried its share price could sink faster than than a dingy with a great white shark attacking it. 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. Case in point: We've spotted 2 warning signs for Shin Hwa World 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. 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.