Here's Why Shinsegae Engineering & Construction (KRX:034300) Has A Meaningful Debt Burden

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.' 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. Importantly, Shinsegae Engineering & Construction Inc. (KRX:034300) does carry debt. But should shareholders be worried about its use of debt?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Shinsegae Engineering & Construction

How Much Debt Does Shinsegae Engineering & Construction Carry?

The image below, which you can click on for greater detail, shows that Shinsegae Engineering & Construction had debt of ₩2.50b at the end of September 2020, a reduction from ₩60.0b over a year. But on the other hand it also has ₩84.6b in cash, leading to a ₩82.1b net cash position.

A Look At Shinsegae Engineering & Construction's Liabilities

According to the last reported balance sheet, Shinsegae Engineering & Construction had liabilities of ₩530.3b due within 12 months, and liabilities of ₩67.4b due beyond 12 months. Offsetting these obligations, it had cash of ₩84.6b as well as receivables valued at ₩198.0b due within 12 months. So it has liabilities totalling ₩315.0b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the ₩89.4b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Shinsegae Engineering & Construction would probably need a major re-capitalization if its creditors were to demand repayment. Given that Shinsegae Engineering & Construction has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

It is just as well that Shinsegae Engineering & Construction's load is not too heavy, because its EBIT was down 40% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Shinsegae Engineering & Construction 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Shinsegae Engineering & Construction 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. Over the last three years, Shinsegae Engineering & Construction actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

Although Shinsegae Engineering & Construction's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of ₩82.1b. The cherry on top was that in converted 147% of that EBIT to free cash flow, bringing in ₩69b. Despite its cash we think that Shinsegae Engineering & Construction seems to struggle to handle its total liabilities, so we are wary of the stock. 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. Case in point: We've spotted 3 warning signs for Shinsegae Engineering & Construction you should be aware of, and 1 of them is potentially serious.

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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