Is Shinkong TextileLtd (TPE:1419) Using Too Much Debt?

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 can see that Shinkong Textile Co.,Ltd. (TPE:1419) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Shinkong TextileLtd

How Much Debt Does Shinkong TextileLtd Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Shinkong TextileLtd had NT$3.06b of debt, an increase on NT$2.70b, over one year. However, it does have NT$1.69b in cash offsetting this, leading to net debt of about NT$1.37b.

A Look At Shinkong TextileLtd's Liabilities

According to the last reported balance sheet, Shinkong TextileLtd had liabilities of NT$3.42b due within 12 months, and liabilities of NT$964.7m due beyond 12 months. On the other hand, it had cash of NT$1.69b and NT$245.8m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$2.45b.

Of course, Shinkong TextileLtd has a market capitalization of NT$12.9b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Strangely Shinkong TextileLtd has a sky high EBITDA ratio of 5.6, implying high debt, but a strong interest coverage of 1k. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. It is well worth noting that Shinkong TextileLtd's EBIT shot up like bamboo after rain, gaining 100% in the last twelve months. That'll make it easier to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Shinkong TextileLtd will need earnings to service that debt. 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 company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last two years, Shinkong TextileLtd produced sturdy free cash flow equating to 78% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Happily, Shinkong TextileLtd's impressive interest cover implies it has the upper hand on its debt. But the stark truth is that we are concerned by its net debt to EBITDA. Looking at the bigger picture, we think Shinkong TextileLtd's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Shinkong TextileLtd that you should be aware of.

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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