We Think Paragon Union Berhad (KLSE:PARAGON) Has A Fair Chunk Of Debt

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.' 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. As with many other companies Paragon Union Berhad (KLSE:PARAGON) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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.

See our latest analysis for Paragon Union Berhad

What Is Paragon Union Berhad's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2020 Paragon Union Berhad had debt of RM20.1m, up from RM16.6m in one year. On the flip side, it has RM1.35m in cash leading to net debt of about RM18.7m.

A Look At Paragon Union Berhad's Liabilities

We can see from the most recent balance sheet that Paragon Union Berhad had liabilities of RM17.3m falling due within a year, and liabilities of RM14.0m due beyond that. Offsetting this, it had RM1.35m in cash and RM8.36m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM21.5m.

While this might seem like a lot, it is not so bad since Paragon Union Berhad has a market capitalization of RM35.9m, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. When analysing debt levels, the balance sheet is the obvious place to start. But it is Paragon Union Berhad'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.

Over 12 months, Paragon Union Berhad made a loss at the EBIT level, and saw its revenue drop to RM41m, which is a fall of 25%. To be frank that doesn't bode well.

Caveat Emptor

While Paragon Union Berhad's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping RM13m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled RM1.1m in negative free cash flow over the last twelve months. So suffice it to say we do consider the stock to be risky. 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. Case in point: We've spotted 2 warning signs for Paragon Union Berhad you should be aware of, and 1 of them doesn't sit too well with us.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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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