PAL GROUP Holdings (TSE:2726) Seems To Use Debt Rather Sparingly

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.' 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. Importantly, PAL GROUP Holdings CO., LTD. (TSE:2726) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for PAL GROUP Holdings

What Is PAL GROUP Holdings's Debt?

The chart below, which you can click on for greater detail, shows that PAL GROUP Holdings had JP¥11.2b in debt in February 2024; about the same as the year before. However, it does have JP¥67.2b in cash offsetting this, leading to net cash of JP¥56.0b.

A Look At PAL GROUP Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that PAL GROUP Holdings had liabilities of JP¥45.0b due within 12 months and liabilities of JP¥18.5b due beyond that. Offsetting these obligations, it had cash of JP¥67.2b as well as receivables valued at JP¥10.4b due within 12 months. So it can boast JP¥14.1b more liquid assets than total liabilities.

This surplus suggests that PAL GROUP Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that PAL GROUP Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

And we also note warmly that PAL GROUP Holdings grew its EBIT by 18% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine PAL GROUP Holdings's ability to maintain a healthy balance sheet going forward. 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 PAL GROUP Holdings 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. During the last three years, PAL GROUP Holdings produced sturdy free cash flow equating to 74% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that PAL GROUP Holdings has net cash of JP¥56.0b, as well as more liquid assets than liabilities. The cherry on top was that in converted 74% of that EBIT to free cash flow, bringing in JP¥10b. So is PAL GROUP Holdings's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example PAL GROUP Holdings has 2 warning signs (and 1 which is concerning) we think you should know about.

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