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

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, ShinHsiung Natural Gas Inc. (GTSM:8908) does carry debt. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for ShinHsiung Natural Gas

How Much Debt Does ShinHsiung Natural Gas Carry?

As you can see below, at the end of September 2020, ShinHsiung Natural Gas had NT$962.5m of debt, up from NT$826.9m a year ago. Click the image for more detail. However, it also had NT$745.2m in cash, and so its net debt is NT$217.3m.

How Healthy Is ShinHsiung Natural Gas' Balance Sheet?

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. Offsetting these obligations, it had cash of NT$745.2m as well as receivables valued at NT$485.5m due within 12 months. So its liabilities total NT$1.86b more than the combination of its cash and short-term receivables.

Since publicly traded ShinHsiung Natural Gas shares are worth a total of NT$10.2b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). 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's net debt is only 0.28 times its EBITDA. And its EBIT covers its interest expense a whopping 381 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The good news is that ShinHsiung Natural Gas has increased its EBIT by 3.0% 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 it is ShinHsiung Natural Gas's earnings that will influence how the balance sheet holds up in the future. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. During the last three years, ShinHsiung Natural Gas produced sturdy free cash flow equating to 63% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

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! It's also worth noting that ShinHsiung Natural Gas is in the Gas Utilities industry, which is often considered to be quite defensive. Looking at the bigger picture, we think ShinHsiung Natural Gas's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of ShinHsiung Natural Gas's earnings per share history for free.

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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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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