Playmates Holdings (HKG:635) Has A Rock Solid Balance Sheet

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Playmates Holdings Limited (HKG:635) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Playmates Holdings

What Is Playmates Holdings's Debt?

The chart below, which you can click on for greater detail, shows that Playmates Holdings had HK$741.4m in debt in December 2020; about the same as the year before. But it also has HK$1.56b in cash to offset that, meaning it has HK$819.3m net cash.

How Strong Is Playmates Holdings' Balance Sheet?

The latest balance sheet data shows that Playmates Holdings had liabilities of HK$701.9m due within a year, and liabilities of HK$250.3m falling due after that. Offsetting these obligations, it had cash of HK$1.56b as well as receivables valued at HK$59.8m due within 12 months. So it can boast HK$668.2m more liquid assets than total liabilities.

This surplus strongly suggests that Playmates Holdings has a rock-solid balance sheet (and the debt is of no concern whatsoever). With this in mind one could posit that its balance sheet means the company is able to handle some adversity. Succinctly put, Playmates Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Playmates Holdings's EBIT dived 14%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. 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 Playmates Holdings 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Playmates Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Playmates Holdings actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Playmates Holdings has net cash of HK$819.3m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of HK$93m, being 108% of its EBIT. So is Playmates Holdings's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example Playmates Holdings has 2 warning signs (and 1 which is a bit concerning) we think you should know about.

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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