Is Song Shang ElectronicsLtd (GTSM:6156) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. As with many other companies Song Shang Electronics Co.,Ltd. (GTSM:6156) makes use of debt. 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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Song Shang ElectronicsLtd

What Is Song Shang ElectronicsLtd's Net Debt?

As you can see below, at the end of September 2020, Song Shang ElectronicsLtd had NT$533.9m of debt, up from NT$459.5m a year ago. Click the image for more detail. However, its balance sheet shows it holds NT$1.03b in cash, so it actually has NT$494.1m net cash.

How Strong Is Song Shang ElectronicsLtd's Balance Sheet?

According to the last reported balance sheet, Song Shang ElectronicsLtd had liabilities of NT$1.67b due within 12 months, and liabilities of NT$312.3m due beyond 12 months. Offsetting these obligations, it had cash of NT$1.03b as well as receivables valued at NT$1.46b due within 12 months. So it actually has NT$506.2m more liquid assets than total liabilities.

This luscious liquidity implies that Song Shang ElectronicsLtd's balance sheet is sturdy like a giant sequoia tree. On this basis we think its balance sheet is strong like a sleek panther or even a proud lion. Simply put, the fact that Song Shang ElectronicsLtd has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Song Shang ElectronicsLtd grew its EBIT by 50% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Song Shang ElectronicsLtd'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Song Shang ElectronicsLtd may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Song Shang ElectronicsLtd actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Song Shang ElectronicsLtd has net cash of NT$494.1m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of NT$291m, being 202% of its EBIT. The bottom line is that we do not find Song Shang ElectronicsLtd's debt levels at all concerning. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Like risks, for instance. Every company has them, and we've spotted 2 warning signs for Song Shang ElectronicsLtd (of which 1 is a bit unpleasant!) you should know about.

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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This article by Simply Wall St is general in nature. 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.
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