Is PNE Solution (KOSDAQ:131390) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 PNE Solution Co., Ltd (KOSDAQ:131390) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for PNE Solution

What Is PNE Solution's Net Debt?

The image below, which you can click on for greater detail, shows that PNE Solution had debt of ₩6.00b at the end of September 2020, a reduction from ₩8.18b over a year. However, its balance sheet shows it holds ₩36.2b in cash, so it actually has ₩30.2b net cash.

How Strong Is PNE Solution's Balance Sheet?

We can see from the most recent balance sheet that PNE Solution had liabilities of ₩108.1b falling due within a year, and liabilities of ₩2.00b due beyond that. On the other hand, it had cash of ₩36.2b and ₩21.0b worth of receivables due within a year. So its liabilities total ₩52.8b more than the combination of its cash and short-term receivables.

Given PNE Solution has a market capitalization of ₩317.9b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, PNE Solution boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, PNE Solution grew its EBIT by 104% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine PNE Solution's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While PNE Solution 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. Looking at the most recent three years, PNE Solution recorded free cash flow of 23% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While PNE Solution does have more liabilities than liquid assets, it also has net cash of ₩30.2b. And we liked the look of last year's 104% year-on-year EBIT growth. So we don't have any problem with PNE Solution's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that PNE Solution is showing 1 warning sign in our investment analysis , you should know about...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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