Here's Why St.Shine OpticalLtd (GTSM:1565) Can Manage Its Debt Responsibly

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. We note that St.Shine Optical Co.,Ltd. (GTSM:1565) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for St.Shine OpticalLtd

What Is St.Shine OpticalLtd's Debt?

As you can see below, at the end of September 2020, St.Shine OpticalLtd had NT$1.41b of debt, up from NT$1.24b a year ago. Click the image for more detail. But it also has NT$1.79b in cash to offset that, meaning it has NT$380.5m net cash.

How Strong Is St.Shine OpticalLtd's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that St.Shine OpticalLtd had liabilities of NT$1.77b due within 12 months and liabilities of NT$808.8m due beyond that. Offsetting these obligations, it had cash of NT$1.79b as well as receivables valued at NT$675.6m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$109.2m.

This state of affairs indicates that St.Shine OpticalLtd's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the NT$13.4b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, St.Shine OpticalLtd boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that St.Shine OpticalLtd's load is not too heavy, because its EBIT was down 36% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 St.Shine OpticalLtd's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While St.Shine OpticalLtd 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. Over the most recent three years, St.Shine OpticalLtd recorded free cash flow worth 61% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

We could understand if investors are concerned about St.Shine OpticalLtd's liabilities, but we can be reassured by the fact it has has net cash of NT$380.5m. So we are not troubled with St.Shine OpticalLtd's debt use. 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. Case in point: We've spotted 1 warning sign for St.Shine OpticalLtd you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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