ShengHua Entertainment CommunicationLtd (GTSM:4806) Is Making Moderate Use Of Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies ShengHua Entertainment Communication co.,Ltd. (GTSM:4806) makes use of debt. But the real question is whether this debt is making the company risky.

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for ShengHua Entertainment CommunicationLtd

What Is ShengHua Entertainment CommunicationLtd's Debt?

The chart below, which you can click on for greater detail, shows that ShengHua Entertainment CommunicationLtd had NT$229.9m in debt in December 2020; about the same as the year before. However, it also had NT$25.3m in cash, and so its net debt is NT$204.7m.

How Healthy Is ShengHua Entertainment CommunicationLtd's Balance Sheet?

The latest balance sheet data shows that ShengHua Entertainment CommunicationLtd had liabilities of NT$204.5m due within a year, and liabilities of NT$187.8m falling due after that. Offsetting these obligations, it had cash of NT$25.3m as well as receivables valued at NT$102.8m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$264.3m.

This deficit isn't so bad because ShengHua Entertainment CommunicationLtd is worth NT$449.2m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. When analysing debt levels, the balance sheet is the obvious place to start. 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.

In the last year ShengHua Entertainment CommunicationLtd wasn't profitable at an EBIT level, but managed to grow its revenue by 478%, to NT$119m. When it comes to revenue growth, that's like nailing the game winning 3-pointer!

Caveat Emptor

Even though ShengHua Entertainment CommunicationLtd managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Indeed, it lost a very considerable NT$88m at the EBIT level. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled NT$7.4m in negative free cash flow over the last twelve months. So to be blunt we think it is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 5 warning signs for ShengHua Entertainment CommunicationLtd (2 make us uncomfortable) you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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