Pa Shun International Holdings (HKG:574) Has Debt But No Earnings; Should You Worry?

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. We note that Pa Shun International Holdings Limited (HKG:574) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Pa Shun International Holdings

How Much Debt Does Pa Shun International Holdings Carry?

As you can see below, Pa Shun International Holdings had CN¥93.3m of debt at June 2021, down from CN¥107.6m a year prior. However, it also had CN¥4.05m in cash, and so its net debt is CN¥89.3m.

How Strong Is Pa Shun International Holdings' Balance Sheet?

According to the last reported balance sheet, Pa Shun International Holdings had liabilities of CN¥220.1m due within 12 months, and liabilities of CN¥24.1m due beyond 12 months. Offsetting these obligations, it had cash of CN¥4.05m as well as receivables valued at CN¥96.0m due within 12 months. So it has liabilities totalling CN¥144.2m more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the CN¥93.1m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. After all, Pa Shun International Holdings would likely require a major re-capitalisation if it had to pay its creditors today. 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 Pa Shun International Holdings 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.

Over 12 months, Pa Shun International Holdings made a loss at the EBIT level, and saw its revenue drop to CN¥265m, which is a fall of 59%. That makes us nervous, to say the least.

Caveat Emptor

Not only did Pa Shun International Holdings's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost a very considerable CN¥14m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through CN¥6.6m in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. 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 Pa Shun International Holdings has 3 warning signs (and 2 which are a bit unpleasant) we think you should know about.

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. 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.
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