Is Shinhwa Contech (KOSDAQ:187270) Using Too Much Debt?

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 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 Shinhwa Contech Co., Ltd (KOSDAQ:187270) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Shinhwa Contech

What Is Shinhwa Contech's Debt?

The image below, which you can click on for greater detail, shows that Shinhwa Contech had debt of ₩17.8b at the end of September 2024, a reduction from ₩23.5b over a year. But it also has ₩24.0b in cash to offset that, meaning it has ₩6.21b net cash.

A Look At Shinhwa Contech's Liabilities

According to the last reported balance sheet, Shinhwa Contech had liabilities of ₩27.7b due within 12 months, and liabilities of ₩1.13b due beyond 12 months. Offsetting this, it had ₩24.0b in cash and ₩12.9b in receivables that were due within 12 months. So it actually has ₩7.98b more liquid assets than total liabilities.

This surplus suggests that Shinhwa Contech is using debt in a way that is appears to be both safe and conservative. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Simply put, the fact that Shinhwa Contech has more cash than debt is arguably a good indication that it can manage its debt safely.

The good news is that Shinhwa Contech has increased its EBIT by 5.8% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But it is Shinhwa Contech's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Shinhwa Contech has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Shinhwa Contech generated free cash flow amounting to a very robust 93% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Shinhwa Contech has net cash of ₩6.21b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of ₩6.9b, being 93% of its EBIT. So we don't think Shinhwa Contech's use of debt is risky. 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 instance, we've identified 1 warning sign for Shinhwa Contech that you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.