Is Pan Asia Data Holdings (HKG:1561) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Pan Asia Data Holdings Inc. (HKG:1561) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Pan Asia Data Holdings

What Is Pan Asia Data Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that Pan Asia Data Holdings had HK$626.9m of debt in December 2022, down from HK$710.0m, one year before. However, because it has a cash reserve of HK$246.4m, its net debt is less, at about HK$380.5m.

How Strong Is Pan Asia Data Holdings' Balance Sheet?

We can see from the most recent balance sheet that Pan Asia Data Holdings had liabilities of HK$1.11b falling due within a year, and liabilities of HK$44.4m due beyond that. Offsetting this, it had HK$246.4m in cash and HK$342.1m in receivables that were due within 12 months. So it has liabilities totalling HK$568.1m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Pan Asia Data Holdings has a market capitalization of HK$1.03b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Pan Asia Data 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.

In the last year Pan Asia Data Holdings wasn't profitable at an EBIT level, but managed to grow its revenue by 36%, to HK$828m. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

Even though Pan Asia Data Holdings managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Its EBIT loss was a whopping HK$104m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of HK$85m. So to be blunt we do think it is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Pan Asia Data Holdings (at least 1 which is a bit concerning) , and understanding them should be part of your investment process.

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.