Is Paladin (HKG:495) Using Debt Sensibly?

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, Paladin Limited (HKG:495) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Paladin

How Much Debt Does Paladin Carry?

You can click the graphic below for the historical numbers, but it shows that Paladin had HK$132.2m of debt in June 2023, down from HK$148.0m, one year before. However, because it has a cash reserve of HK$44.7m, its net debt is less, at about HK$87.5m.

How Healthy Is Paladin's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Paladin had liabilities of HK$123.8m due within 12 months and liabilities of HK$22.8m due beyond that. On the other hand, it had cash of HK$44.7m and HK$3.75m worth of receivables due within a year. So its liabilities total HK$98.2m more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of HK$77.1m, we think shareholders really should watch Paladin's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Paladin 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 Paladin had a loss before interest and tax, and actually shrunk its revenue by 36%, to HK$18m. To be frank that doesn't bode well.

Caveat Emptor

Not only did Paladin's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping HK$31m. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. It's fair to say the loss of HK$37m didn't encourage us either; we'd like to see a profit. And until that time we think this is a risky stock. 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. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Paladin (of which 3 are potentially serious!) you should know about.

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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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.