Stock Analysis

Here's Why Shinpo (TYO:5903) Can Manage Its Debt Responsibly

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TSE:5903
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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.' 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 Shinpo Co., Ltd. (TYO:5903) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

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How Much Debt Does Shinpo Carry?

As you can see below, at the end of December 2020, Shinpo had JP¥207.0m of debt, up from JP¥56.0m a year ago. Click the image for more detail. But on the other hand it also has JP¥2.80b in cash, leading to a JP¥2.59b net cash position.

debt-equity-history-analysis
JASDAQ:5903 Debt to Equity History March 24th 2021

A Look At Shinpo's Liabilities

Zooming in on the latest balance sheet data, we can see that Shinpo had liabilities of JP¥915.0m due within 12 months and liabilities of JP¥498.0m due beyond that. Offsetting this, it had JP¥2.80b in cash and JP¥703.0m in receivables that were due within 12 months. So it can boast JP¥2.09b more liquid assets than total liabilities.

This luscious liquidity implies that Shinpo's balance sheet is sturdy like a giant sequoia tree. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Shinpo boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Shinpo's saving grace is its low debt levels, because its EBIT has tanked 44% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Shinpo can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Shinpo 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. In the last three years, Shinpo created free cash flow amounting to 7.5% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Shinpo has JP¥2.59b in net cash and a decent-looking balance sheet. So we don't have any problem with Shinpo's use of debt. 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 instance, we've identified 4 warning signs for Shinpo (1 is concerning) you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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About TSE:5903

Shinpo

Shinpo Co., Ltd. manufactures and sells smokeless grills in Japan, China, South Korea, Taiwan, and internationally.

Excellent balance sheet with acceptable track record.

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