ShengHua Entertainment CommunicationLtd (GTSM:4806) Is Carrying A Fair Bit Of 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 ShengHua Entertainment Communication co.,Ltd. (GTSM:4806) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for ShengHua Entertainment CommunicationLtd

What Is ShengHua Entertainment CommunicationLtd's Net Debt?

The chart below, which you can click on for greater detail, shows that ShengHua Entertainment CommunicationLtd had NT$225.7m in debt in September 2020; about the same as the year before. Net debt is about the same, since the it doesn't have much cash.

How Strong Is ShengHua Entertainment CommunicationLtd's Balance Sheet?

According to the last reported balance sheet, ShengHua Entertainment CommunicationLtd had liabilities of NT$180.6m due within 12 months, and liabilities of NT$187.2m due beyond 12 months. On the other hand, it had cash of NT$1.96m and NT$100.4m worth of receivables due within a year. So its liabilities total NT$265.5m more than the combination of its cash and short-term receivables.

ShengHua Entertainment CommunicationLtd has a market capitalization of NT$499.5m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. There's no doubt that we learn most about debt from the balance sheet. But it is ShengHua Entertainment CommunicationLtd's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, ShengHua Entertainment CommunicationLtd reported revenue of NT$119m, which is a gain of 364%, although it did not report any earnings before interest and tax. That's virtually the hole-in-one of revenue growth!

Caveat Emptor

While we can certainly appreciate ShengHua Entertainment CommunicationLtd's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Indeed, it lost a very considerable NT$116m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled NT$76m in negative free cash flow over the last twelve months. So in short it's a really risky stock. 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. Be aware that ShengHua Entertainment CommunicationLtd is showing 5 warning signs in our investment analysis , and 2 of those shouldn't be ignored...

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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