Shinhung (KRX:004080) Has A Pretty Healthy Balance Sheet

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Shinhung Co., Ltd (KRX:004080) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. 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 Shinhung

How Much Debt Does Shinhung Carry?

The image below, which you can click on for greater detail, shows that Shinhung had debt of ₩26.1b at the end of September 2020, a reduction from ₩28.8b over a year. However, it does have ₩6.09b in cash offsetting this, leading to net debt of about ₩20.0b.

How Healthy Is Shinhung's Balance Sheet?

We can see from the most recent balance sheet that Shinhung had liabilities of ₩48.6b falling due within a year, and liabilities of ₩14.2b due beyond that. On the other hand, it had cash of ₩6.09b and ₩15.3b worth of receivables due within a year. So it has liabilities totalling ₩41.4b more than its cash and near-term receivables, combined.

Shinhung has a market capitalization of ₩113.6b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). 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).

With a debt to EBITDA ratio of 2.4, Shinhung uses debt artfully but responsibly. And the fact that its trailing twelve months of EBIT was 7.4 times its interest expenses harmonizes with that theme. Notably, Shinhung's EBIT launched higher than Elon Musk, gaining a whopping 1,303% on last year. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Shinhung 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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Shinhung 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

Shinhung's conversion of EBIT to free cash flow was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its EBIT growth rate. It's also worth noting that Shinhung is in the Medical Equipment industry, which is often considered to be quite defensive. When we consider all the factors mentioned above, we do feel a bit cautious about Shinhung's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of Shinhung's earnings per share history for free.

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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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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