Is Shinsegae Engineering & Construction (KRX:034300) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Shinsegae Engineering & Construction Inc. (KRX:034300) does carry debt. 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. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Shinsegae Engineering & Construction

What Is Shinsegae Engineering & Construction's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Shinsegae Engineering & Construction had ₩2.50b of debt in September 2020, down from ₩60.0b, one year before. However, its balance sheet shows it holds ₩84.6b in cash, so it actually has ₩82.1b net cash.

How Strong Is Shinsegae Engineering & Construction's Balance Sheet?

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 its liabilities outweigh the sum of its cash and (near-term) receivables by ₩315.0b.

This deficit casts a shadow over the ₩205.6b company, like a colossus towering over mere mortals. 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. Shinsegae Engineering & Construction boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant 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. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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. Happily for any shareholders, Shinsegae Engineering & Construction actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While Shinsegae Engineering & Construction does have more liabilities than liquid assets, it also 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. So while Shinsegae Engineering & Construction does not have a great balance sheet, it's certainly not too bad. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for Shinsegae Engineering & Construction you should be aware of, and 1 of them is a bit concerning.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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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