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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Shiny Chemical Industrial Co., Ltd. (TWSE:1773) does carry debt. But the real question is whether this debt is making the company risky.
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.
Check out our latest analysis for Shiny Chemical Industrial
The image below, which you can click on for greater detail, shows that at June 2024 Shiny Chemical Industrial had debt of NT$3.41b, up from NT$3.28b in one year. However, it also had NT$308.0m in cash, and so its net debt is NT$3.11b.
The latest balance sheet data shows that Shiny Chemical Industrial had liabilities of NT$4.39b due within a year, and liabilities of NT$1.95b falling due after that. Offsetting these obligations, it had cash of NT$308.0m as well as receivables valued at NT$1.40b due within 12 months. So it has liabilities totalling NT$4.63b more than its cash and near-term receivables, combined.
Of course, Shiny Chemical Industrial has a market capitalization of NT$42.5b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Shiny Chemical Industrial has a low net debt to EBITDA ratio of only 1.2. And its EBIT covers its interest expense a whopping 58.2 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Fortunately, Shiny Chemical Industrial grew its EBIT by 6.3% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Shiny Chemical Industrial 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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Shiny Chemical Industrial barely recorded positive free cash flow, in total. Some might say that's a concern, when it comes considering how easily it would be for it to down debt.
When it comes to the balance sheet, the standout positive for Shiny Chemical Industrial was the fact that it seems able to cover its interest expense with its EBIT confidently. But the other factors we noted above weren't so encouraging. To be specific, it seems about as good at converting EBIT to free cash flow as wet socks are at keeping your feet warm. Considering this range of data points, we think Shiny Chemical Industrial is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Shiny Chemical Industrial that you should be aware of.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.