Here's Why Pan Ocean (KRX:028670) Has A Meaningful Debt Burden

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 note that Pan Ocean Co., Ltd. (KRX:028670) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Pan Ocean

What Is Pan Ocean's Debt?

As you can see below, at the end of December 2023, Pan Ocean had ₩366.8b of debt, up from ₩329.1b a year ago. Click the image for more detail. However, it does have ₩1.04t in cash offsetting this, leading to net cash of ₩668.6b.

A Look At Pan Ocean's Liabilities

We can see from the most recent balance sheet that Pan Ocean had liabilities of ₩1.29t falling due within a year, and liabilities of ₩1.85t due beyond that. Offsetting this, it had ₩1.04t in cash and ₩231.6b in receivables that were due within 12 months. So it has liabilities totalling ₩1.87t more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of ₩2.38t, so it does suggest shareholders should keep an eye on Pan Ocean's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Despite its noteworthy liabilities, Pan Ocean boasts net cash, so it's fair to say it does not have a heavy debt load!

Importantly, Pan Ocean's EBIT fell a jaw-dropping 51% in the last twelve months. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. 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 Pan Ocean'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Pan Ocean 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. Happily for any shareholders, Pan Ocean actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While Pan Ocean does have more liabilities than liquid assets, it also has net cash of ₩668.6b. The cherry on top was that in converted 111% of that EBIT to free cash flow, bringing in ₩434b. So although we see some areas for improvement, we're not too worried about Pan Ocean's balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Pan Ocean is showing 3 warning signs in our investment analysis , you should know about...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.