Is Pandora Investments (CSE:PND) Using Too Much Debt?

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 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, Pandora Investments Public Limited (CSE:PND) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Pandora Investments

What Is Pandora Investments's Net Debt?

The chart below, which you can click on for greater detail, shows that Pandora Investments had €222.2m in debt in June 2022; about the same as the year before. However, because it has a cash reserve of €46.2m, its net debt is less, at about €176.0m.

A Look At Pandora Investments' Liabilities

We can see from the most recent balance sheet that Pandora Investments had liabilities of €148.4m falling due within a year, and liabilities of €314.3m due beyond that. Offsetting this, it had €46.2m in cash and €17.3m in receivables that were due within 12 months. So its liabilities total €399.2m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the €27.6m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Pandora Investments would likely require a major re-capitalisation if it had to pay its creditors today.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 1.5 times and a disturbingly high net debt to EBITDA ratio of 22.5 hit our confidence in Pandora Investments like a one-two punch to the gut. The debt burden here is substantial. Even worse, Pandora Investments saw its EBIT tank 49% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Pandora Investments'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, 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, Pandora Investments actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

On the face of it, Pandora Investments's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Overall, it seems to us that Pandora Investments's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. Case in point: We've spotted 3 warning signs for Pandora Investments you should be aware of, and 2 of them shouldn't be ignored.

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. 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.