Is Shihlin Electric & Engineering (TWSE:1503) Using Too Much Debt?

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, Shihlin Electric & Engineering Corp. (TWSE:1503) does carry debt. But the real question is whether this debt is making the company risky.

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. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Shihlin Electric & Engineering

What Is Shihlin Electric & Engineering's Net Debt?

As you can see below, Shihlin Electric & Engineering had NT$926.8m of debt at September 2024, down from NT$1.88b a year prior. However, its balance sheet shows it holds NT$3.07b in cash, so it actually has NT$2.15b net cash.

A Look At Shihlin Electric & Engineering's Liabilities

Zooming in on the latest balance sheet data, we can see that Shihlin Electric & Engineering had liabilities of NT$16.6b due within 12 months and liabilities of NT$2.72b due beyond that. Offsetting this, it had NT$3.07b in cash and NT$8.94b in receivables that were due within 12 months. So its liabilities total NT$7.32b more than the combination of its cash and short-term receivables.

Of course, Shihlin Electric & Engineering has a market capitalization of NT$103.9b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. 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.

On top of that, Shihlin Electric & Engineering grew its EBIT by 33% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Shihlin Electric & Engineering's ability to maintain a healthy balance sheet going forward. 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. Over the most recent three years, Shihlin Electric & Engineering recorded free cash flow worth 76% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

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$2.15b. And we liked the look of last year's 33% year-on-year EBIT growth. So is Shihlin Electric & Engineering's debt a risk? It doesn't seem so to us. 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 Shihlin Electric & Engineering's earnings per share history for free.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.