Is Pan Asia Environmental Protection Group (HKG:556) Using Debt Sensibly?

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. We can see that Pan Asia Environmental Protection Group Limited (HKG:556) does use debt in its business. 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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Pan Asia Environmental Protection Group

How Much Debt Does Pan Asia Environmental Protection Group Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2020 Pan Asia Environmental Protection Group had CN¥51.0m of debt, an increase on CN¥48.8m, over one year. But it also has CN¥1.22b in cash to offset that, meaning it has CN¥1.17b net cash.

How Healthy Is Pan Asia Environmental Protection Group's Balance Sheet?

We can see from the most recent balance sheet that Pan Asia Environmental Protection Group had liabilities of CN¥119.4m falling due within a year, and liabilities of CN¥24.0m due beyond that. Offsetting these obligations, it had cash of CN¥1.22b as well as receivables valued at CN¥47.5m due within 12 months. So it can boast CN¥1.12b more liquid assets than total liabilities.

This excess liquidity is a great indication that Pan Asia Environmental Protection Group's balance sheet is just as strong as racists are weak. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Pan Asia Environmental Protection Group has more cash than debt is arguably a good indication that it can manage its debt safely. 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 Pan Asia Environmental Protection Group 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.

In the last year Pan Asia Environmental Protection Group had a loss before interest and tax, and actually shrunk its revenue by 61%, to CN¥62m. That makes us nervous, to say the least.

So How Risky Is Pan Asia Environmental Protection Group?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And we do note that Pan Asia Environmental Protection Group had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through CN¥4.6m of cash and made a loss of CN¥55m. With only CN¥1.17b on the balance sheet, it would appear that its going to need to raise capital again soon. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Pan Asia Environmental Protection Group is showing 3 warning signs in our investment analysis , and 1 of those makes us a bit uncomfortable...

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.

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