Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies PA Co., Ltd. (TSE:4766) makes use of debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for PA
How Much Debt Does PA Carry?
The image below, which you can click on for greater detail, shows that PA had debt of JPĀ„636.0m at the end of March 2024, a reduction from JPĀ„690.0m over a year. However, its balance sheet shows it holds JPĀ„843.0m in cash, so it actually has JPĀ„207.0m net cash.
How Healthy Is PA's Balance Sheet?
We can see from the most recent balance sheet that PA had liabilities of JPĀ„700.0m falling due within a year, and liabilities of JPĀ„223.0m due beyond that. Offsetting these obligations, it had cash of JPĀ„843.0m as well as receivables valued at JPĀ„163.0m due within 12 months. So it actually has JPĀ„83.0m more liquid assets than total liabilities.
This short term liquidity is a sign that PA could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that PA has more cash than debt is arguably a good indication that it can manage its debt safely.
On top of that, PA grew its EBIT by 89% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is PA'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While PA 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 two years, PA actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
Summing Up
While it is always sensible to investigate a company's debt, in this case PA has JPĀ„207.0m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of JPĀ„105m, being 123% of its EBIT. So is PA'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. However, not all investment risk resides within the balance sheet - far from it. For example - PA has 1 warning sign we think you should be aware of.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com
About TSE:4766
PA
Develops revitalization projects for individuals and businesses in Japan.
Adequate balance sheet with questionable track record.
