These 4 Measures Indicate That Great Wall Pan Asia Holdings (HKG:583) Is Using Debt Extensively

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Great Wall Pan Asia Holdings Limited (HKG:583) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Great Wall Pan Asia Holdings

What Is Great Wall Pan Asia Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2023 Great Wall Pan Asia Holdings had debt of HK$5.18b, up from HK$4.75b in one year. However, because it has a cash reserve of HK$223.1m, its net debt is less, at about HK$4.96b.

How Strong Is Great Wall Pan Asia Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Great Wall Pan Asia Holdings had liabilities of HK$5.34b due within 12 months and liabilities of HK$18.2m due beyond that. Offsetting this, it had HK$223.1m in cash and HK$27.7m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$5.11b.

This deficit casts a shadow over the HK$348.0m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Great Wall Pan Asia Holdings would probably need a major re-capitalization if its creditors were to demand repayment.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With a net debt to EBITDA ratio of 8.2, it's fair to say Great Wall Pan Asia Holdings does have a significant amount of debt. But the good news is that it boasts fairly comforting interest cover of 2.7 times, suggesting it can responsibly service its obligations. The good news is that Great Wall Pan Asia Holdings improved its EBIT by 5.3% over the last twelve months, thus gradually reducing its debt levels relative to its earnings. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Great Wall Pan Asia Holdings's earnings that will influence how the balance sheet holds up in the future. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Great Wall Pan Asia Holdings reported free cash flow worth 9.0% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

To be frank both Great Wall Pan Asia Holdings's net debt to EBITDA and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. Having said that, its ability to grow its EBIT isn't such a worry. Taking into account all the aforementioned factors, it looks like Great Wall Pan Asia Holdings has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. 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. Case in point: We've spotted 4 warning signs for Great Wall Pan Asia Holdings you should be aware of, and 2 of them are a bit unpleasant.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.