Shinsung Delta TechLtd (KOSDAQ:065350) Seems To Be Using A Lot Of Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Shinsung Delta Tech Co.,Ltd. (KOSDAQ:065350) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Shinsung Delta TechLtd

What Is Shinsung Delta TechLtd's Net Debt?

As you can see below, Shinsung Delta TechLtd had ₩133.6b of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of ₩24.0b, its net debt is less, at about ₩109.6b.

How Healthy Is Shinsung Delta TechLtd's Balance Sheet?

The latest balance sheet data shows that Shinsung Delta TechLtd had liabilities of ₩201.1b due within a year, and liabilities of ₩34.4b falling due after that. Offsetting this, it had ₩24.0b in cash and ₩121.0b in receivables that were due within 12 months. So its liabilities total ₩90.5b more than the combination of its cash and short-term receivables.

Shinsung Delta TechLtd has a market capitalization of ₩170.0b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). 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).

Shinsung Delta TechLtd has a rather high debt to EBITDA ratio of 5.0 which suggests a meaningful debt load. But the good news is that it boasts fairly comforting interest cover of 2.5 times, suggesting it can responsibly service its obligations. Even worse, Shinsung Delta TechLtd saw its EBIT tank 22% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Shinsung Delta TechLtd'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 company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Shinsung Delta TechLtd burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Shinsung Delta TechLtd's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. But at least its level of total liabilities is not so bad. After considering the datapoints discussed, we think Shinsung Delta TechLtd has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 5 warning signs for Shinsung Delta TechLtd (2 are significant) 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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