Is Shin Heung Energy & ElectronicsLtd (KOSDAQ:243840) A Risky Investment?

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 Shin Heung Energy & Electronics Co.,Ltd. (KOSDAQ:243840) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Shin Heung Energy & ElectronicsLtd

How Much Debt Does Shin Heung Energy & ElectronicsLtd Carry?

As you can see below, at the end of September 2020, Shin Heung Energy & ElectronicsLtd had ₩169.1b of debt, up from ₩158.4b a year ago. Click the image for more detail. However, because it has a cash reserve of ₩38.9b, its net debt is less, at about ₩130.2b.

How Strong Is Shin Heung Energy & ElectronicsLtd's Balance Sheet?

The latest balance sheet data shows that Shin Heung Energy & ElectronicsLtd had liabilities of ₩152.8b due within a year, and liabilities of ₩67.8b falling due after that. Offsetting these obligations, it had cash of ₩38.9b as well as receivables valued at ₩46.1b due within 12 months. So its liabilities total ₩135.5b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Shin Heung Energy & ElectronicsLtd has a market capitalization of ₩327.1b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Shin Heung Energy & ElectronicsLtd's debt is 3.0 times its EBITDA, and its EBIT cover its interest expense 5.2 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Shin Heung Energy & ElectronicsLtd grew its EBIT by 8.6% in the last year. That's far from incredible but it is a good thing, when it comes to paying off debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Shin Heung Energy & ElectronicsLtd 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Shin Heung Energy & ElectronicsLtd saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Shin Heung Energy & ElectronicsLtd's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. For example, its EBIT growth rate is relatively strong. Taking the abovementioned factors together we do think Shin Heung Energy & ElectronicsLtd's debt poses some risks to the business. While that debt can boost returns, we think the company has enough leverage now. 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 example, we've discovered 2 warning signs for Shin Heung Energy & ElectronicsLtd that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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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