Is ShinHsiung Natural Gas (GTSM:8908) A Risky Investment?

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. We can see that ShinHsiung Natural Gas Inc. (GTSM:8908) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for ShinHsiung Natural Gas

How Much Debt Does ShinHsiung Natural Gas Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 ShinHsiung Natural Gas had NT$962.5m of debt, an increase on NT$826.9m, over one year. On the flip side, it has NT$803.1m in cash leading to net debt of about NT$159.4m.

A Look At ShinHsiung Natural Gas's Liabilities

The latest balance sheet data shows that ShinHsiung Natural Gas had liabilities of NT$2.21b due within a year, and liabilities of NT$878.3m falling due after that. On the other hand, it had cash of NT$803.1m and NT$485.5m worth of receivables due within a year. So it has liabilities totalling NT$1.80b more than its cash and near-term receivables, combined.

Of course, ShinHsiung Natural Gas has a market capitalization of NT$10.4b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

ShinHsiung Natural Gas has a low net debt to EBITDA ratio of only 0.21. And its EBIT covers its interest expense a whopping 144 times over. So we're pretty relaxed about its super-conservative use of debt. The good news is that ShinHsiung Natural Gas has increased its EBIT by 2.8% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since ShinHsiung Natural Gas will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, ShinHsiung Natural Gas recorded free cash flow worth 63% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

ShinHsiung Natural Gas's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its net debt to EBITDA also supports that impression! We would also note that Gas Utilities industry companies like ShinHsiung Natural Gas commonly do use debt without problems. Zooming out, ShinHsiung Natural Gas seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. Over time, share prices tend to follow earnings per share, so if you're interested in ShinHsiung Natural Gas, you may well want to click here to check an interactive graph of its earnings per share history.

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. 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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