Does Shihlin Development (GTSM:5324) Have A Healthy Balance Sheet?

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. Importantly, Shihlin Development Company Limited (GTSM:5324) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Shihlin Development

What Is Shihlin Development's Debt?

As you can see below, at the end of September 2020, Shihlin Development had NT$1.33b of debt, up from NT$1.05b a year ago. Click the image for more detail. However, because it has a cash reserve of NT$772.5m, its net debt is less, at about NT$556.8m.

How Healthy Is Shihlin Development's Balance Sheet?

According to the last reported balance sheet, Shihlin Development had liabilities of NT$1.21b due within 12 months, and liabilities of NT$1.82b due beyond 12 months. Offsetting these obligations, it had cash of NT$772.5m as well as receivables valued at NT$20.8m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by NT$2.24b.

Given this deficit is actually higher than the company's market capitalization of NT$1.50b, we think shareholders really should watch Shihlin Development's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Shihlin Development 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.

Over 12 months, Shihlin Development made a loss at the EBIT level, and saw its revenue drop to NT$467m, which is a fall of 39%. To be frank that doesn't bode well.

Caveat Emptor

Not only did Shihlin Development's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping NT$205m. Considering that alongside the liabilities mentioned above make us nervous about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it had negative free cash flow of NT$127m over the last twelve months. So suffice it to say we consider the stock to be risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 4 warning signs for Shihlin Development (1 is concerning!) that you should be aware of before investing here.

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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