We Think Shin Heung Energy & ElectronicsLtd (KOSDAQ:243840) Is Taking Some Risk With Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Heung Energy & Electronics Co.,Ltd. (KOSDAQ:243840) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Shin Heung Energy & ElectronicsLtd

What Is Shin Heung Energy & ElectronicsLtd's Net Debt?

As you can see below, at the end of June 2020, Shin Heung Energy & ElectronicsLtd had ₩177.0b of debt, up from ₩155.4b a year ago. Click the image for more detail. However, it also had ₩42.1b in cash, and so its net debt is ₩134.9b.

A Look At Shin Heung Energy & ElectronicsLtd's Liabilities

According to the last reported balance sheet, Shin Heung Energy & ElectronicsLtd had liabilities of ₩149.9b due within 12 months, and liabilities of ₩73.6b due beyond 12 months. Offsetting this, it had ₩42.1b in cash and ₩37.0b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩144.5b.

While this might seem like a lot, it is not so bad since Shin Heung Energy & ElectronicsLtd has a market capitalization of ₩301.2b, 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.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Shin Heung Energy & ElectronicsLtd's debt is 3.5 times its EBITDA, and its EBIT cover its interest expense 4.5 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. If Shin Heung Energy & ElectronicsLtd can keep growing EBIT at last year's rate of 13% over the last year, then it will find its debt load easier to manage. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Shin Heung Energy & ElectronicsLtd's ability to maintain a healthy balance sheet going forward. 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. During the last three years, Shin Heung Energy & ElectronicsLtd burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

We'd go so far as to say Shin Heung Energy & ElectronicsLtd's conversion of EBIT to free cash flow was disappointing. But at least it's pretty decent at growing its EBIT; that's encouraging. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Shin Heung Energy & ElectronicsLtd stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Shin Heung Energy & ElectronicsLtd (1 can't be ignored!) 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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