Does Pico Far East Holdings (HKG:752) Have A Healthy Balance Sheet?

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.' 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. As with many other companies Pico Far East Holdings Limited (HKG:752) makes use of debt. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Pico Far East Holdings

What Is Pico Far East Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that as of October 2020 Pico Far East Holdings had HK$665.6m of debt, an increase on HK$612.1m, over one year. But it also has HK$1.30b in cash to offset that, meaning it has HK$636.2m net cash.

How Strong Is Pico Far East Holdings' Balance Sheet?

According to the last reported balance sheet, Pico Far East Holdings had liabilities of HK$1.98b due within 12 months, and liabilities of HK$692.4m due beyond 12 months. On the other hand, it had cash of HK$1.30b and HK$1.50b worth of receivables due within a year. So it can boast HK$138.7m more liquid assets than total liabilities.

This surplus suggests that Pico Far East Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Pico Far East Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

Importantly, Pico Far East Holdings's EBIT fell a jaw-dropping 94% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Pico Far East Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Pico Far East 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. During the last three years, Pico Far East Holdings produced sturdy free cash flow equating to 70% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While it is always sensible to investigate a company's debt, in this case Pico Far East Holdings has HK$636.2m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 70% of that EBIT to free cash flow, bringing in HK$119m. So we don't have any problem with Pico Far East Holdings's use of debt. 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 Pico Far East Holdings you should be aware of.

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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