Is Shihlin Electric & Engineering (TWSE:1503) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that Shihlin Electric & Engineering Corp. (TWSE:1503) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Shihlin Electric & Engineering

What Is Shihlin Electric & Engineering's Net Debt?

The image below, which you can click on for greater detail, shows that Shihlin Electric & Engineering had debt of NT$548.8m at the end of June 2024, a reduction from NT$2.04b over a year. However, its balance sheet shows it holds NT$3.36b in cash, so it actually has NT$2.81b net cash.

A Look At Shihlin Electric & Engineering's Liabilities

The latest balance sheet data shows that Shihlin Electric & Engineering had liabilities of NT$18.2b due within a year, and liabilities of NT$2.80b falling due after that. Offsetting these obligations, it had cash of NT$3.36b as well as receivables valued at NT$10.6b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$7.05b.

Given Shihlin Electric & Engineering has a market capitalization of NT$114.9b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Shihlin Electric & Engineering also has more cash than debt, so we're pretty confident it can manage its debt safely.

And we also note warmly that Shihlin Electric & Engineering grew its EBIT by 19% last year, making its debt load easier to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Shihlin Electric & Engineering can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Shihlin Electric & Engineering 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. During the last three years, Shihlin Electric & Engineering produced sturdy free cash flow equating to 75% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

We could understand if investors are concerned about Shihlin Electric & Engineering's liabilities, but we can be reassured by the fact it has has net cash of NT$2.81b. The cherry on top was that in converted 75% of that EBIT to free cash flow, bringing in NT$2.9b. So is Shihlin Electric & Engineering's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Shihlin Electric & Engineering 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.