We Think Shiny Chemical Industrial (TWSE:1773) Can Stay On Top Of Its 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. We can see that Shiny Chemical Industrial Co., Ltd. (TWSE:1773) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Shiny Chemical Industrial

What Is Shiny Chemical Industrial's Debt?

The chart below, which you can click on for greater detail, shows that Shiny Chemical Industrial had NT$4.06b in debt in September 2024; about the same as the year before. On the flip side, it has NT$263.2m in cash leading to net debt of about NT$3.80b.

A Look At Shiny Chemical Industrial's Liabilities

According to the last reported balance sheet, Shiny Chemical Industrial had liabilities of NT$2.84b due within 12 months, and liabilities of NT$3.28b due beyond 12 months. Offsetting these obligations, it had cash of NT$263.2m as well as receivables valued at NT$1.52b due within 12 months. So it has liabilities totalling NT$4.33b more than its cash and near-term receivables, combined.

Given Shiny Chemical Industrial has a market capitalization of NT$36.3b, 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.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Shiny Chemical Industrial has a low net debt to EBITDA ratio of only 1.4. And its EBIT covers its interest expense a whopping 45.5 times over. So we're pretty relaxed about its super-conservative use of debt. And we also note warmly that Shiny Chemical Industrial grew its EBIT by 18% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Shiny Chemical Industrial will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Shiny Chemical Industrial reported free cash flow worth 2.3% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

On our analysis Shiny Chemical Industrial's interest cover should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. In particular, conversion of EBIT to free cash flow gives us cold feet. When we consider all the elements mentioned above, it seems to us that Shiny Chemical Industrial is managing its debt quite well. But a word of caution: we think debt levels are high enough to justify ongoing monitoring. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Shiny Chemical Industrial you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.