Does Pan EntertainmentLtd (KOSDAQ:068050) Have A Healthy Balance Sheet?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Pan Entertainment Co.,Ltd. (KOSDAQ:068050) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Pan EntertainmentLtd

What Is Pan EntertainmentLtd's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Pan EntertainmentLtd had ₩18.2b of debt, an increase on ₩17.2b, over one year. However, because it has a cash reserve of ₩2.77b, its net debt is less, at about ₩15.4b.

How Strong Is Pan EntertainmentLtd's Balance Sheet?

We can see from the most recent balance sheet that Pan EntertainmentLtd had liabilities of ₩20.8b falling due within a year, and liabilities of ₩4.16b due beyond that. Offsetting this, it had ₩2.77b in cash and ₩220 in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₩22.2b.

Since publicly traded Pan EntertainmentLtd shares are worth a total of ₩179.8b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

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.

Pan EntertainmentLtd's debt is 4.5 times its EBITDA, and its EBIT cover its interest expense 3.4 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. However, the silver lining was that Pan EntertainmentLtd achieved a positive EBIT of ₩2.6b in the last twelve months, an improvement on the prior year's loss. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Pan EntertainmentLtd'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. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. In the last year, Pan EntertainmentLtd created free cash flow amounting to 19% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

While Pan EntertainmentLtd's interest cover makes us cautious about it, its track record of managing its debt, based on its EBITDA, is no better. But its not so bad at staying on top of its total liabilities. Taking the abovementioned factors together we do think Pan EntertainmentLtd's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Pan EntertainmentLtd that 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. 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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