Is Pacific Basin Shipping (HKG:2343) Using Too Much Debt?

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.' 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. We can see that Pacific Basin Shipping Limited (HKG:2343) does use debt in its business. But the real question is whether this debt is making the company risky.

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. 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.

See our latest analysis for Pacific Basin Shipping

How Much Debt Does Pacific Basin Shipping Carry?

As you can see below, Pacific Basin Shipping had US$447.5m of debt at June 2022, down from US$771.6m a year prior. However, its balance sheet shows it holds US$516.3m in cash, so it actually has US$68.8m net cash.

How Strong Is Pacific Basin Shipping's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Pacific Basin Shipping had liabilities of US$417.3m due within 12 months and liabilities of US$430.5m due beyond that. On the other hand, it had cash of US$516.3m and US$179.6m worth of receivables due within a year. So its liabilities total US$151.9m more than the combination of its cash and short-term receivables.

Given Pacific Basin Shipping has a market capitalization of US$1.74b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Pacific Basin Shipping boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Pacific Basin Shipping grew its EBIT by 395% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. 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 Pacific Basin Shipping 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Pacific Basin Shipping has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Pacific Basin Shipping recorded free cash flow worth a fulsome 99% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

We could understand if investors are concerned about Pacific Basin Shipping's liabilities, but we can be reassured by the fact it has has net cash of US$68.8m. The cherry on top was that in converted 99% of that EBIT to free cash flow, bringing in US$996m. So is Pacific Basin Shipping's debt a risk? It doesn't seem so to us. 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. Be aware that Pacific Basin Shipping is showing 4 warning signs in our investment analysis , and 1 of those is significant...

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. 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.