Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 PC Partner Group Limited (HKG:1263) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 PC Partner Group
What Is PC Partner Group's Debt?
As you can see below, PC Partner Group had HK$1.34b of debt, at June 2020, which is about the same as the year before. You can click the chart for greater detail. However, it also had HK$738.3m in cash, and so its net debt is HK$598.0m.
How Healthy Is PC Partner Group's Balance Sheet?
The latest balance sheet data shows that PC Partner Group had liabilities of HK$2.68b due within a year, and liabilities of HK$122.8m falling due after that. On the other hand, it had cash of HK$738.3m and HK$1.43b worth of receivables due within a year. So its liabilities total HK$634.7m more than the combination of its cash and short-term receivables.
This is a mountain of leverage relative to its market capitalization of HK$941.4m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
PC Partner Group's net debt is sitting at a very reasonable 2.4 times its EBITDA, while its EBIT covered its interest expense just 6.0 times last year. While that doesn't worry us too much, it does suggest the interest payments are somewhat of a burden. We also note that PC Partner Group improved its EBIT from a last year's loss to a positive HK$196m. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if PC Partner Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
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 the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, PC Partner Group actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Our View
On our analysis PC Partner Group's conversion of EBIT to free cash flow should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. For instance it seems like it has to struggle a bit to handle its total liabilities. When we consider all the factors mentioned above, we do feel a bit cautious about PC Partner Group's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for PC Partner Group 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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This article by Simply Wall St is general in nature. 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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About SEHK:1263
PC Partner Group
An investment holding company, designs, develops, manufactures, and sells computer electronics.
Flawless balance sheet established dividend payer.
