Parkson Holdings Berhad (KLSE:PARKSON) Has A Somewhat Strained Balance Sheet

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 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. We note that Parkson Holdings Berhad (KLSE:PARKSON) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Parkson Holdings Berhad

What Is Parkson Holdings Berhad's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Parkson Holdings Berhad had RM1.39b of debt in December 2021, down from RM1.94b, one year before. However, because it has a cash reserve of RM1.35b, its net debt is less, at about RM39.7m.

How Healthy Is Parkson Holdings Berhad's Balance Sheet?

We can see from the most recent balance sheet that Parkson Holdings Berhad had liabilities of RM3.70b falling due within a year, and liabilities of RM3.03b due beyond that. Offsetting this, it had RM1.35b in cash and RM452.5m in receivables that were due within 12 months. So its liabilities total RM4.93b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the RM183.8m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Parkson Holdings Berhad would probably need a major re-capitalization if its creditors were to demand repayment.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Parkson Holdings Berhad has a net debt to EBITDA ratio of 0.081, suggesting a very conservative balance sheet. But strangely, EBIT was only 0.81 times interest expenses, suggesting the that may paint an overly pretty picture of the stock. It is well worth noting that Parkson Holdings Berhad's EBIT shot up like bamboo after rain, gaining 57% in the last twelve months. That'll make it easier to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Parkson Holdings Berhad will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Parkson Holdings Berhad produced sturdy free cash flow equating to 52% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

While Parkson Holdings Berhad's level of total liabilities has us nervous. To wit both its EBIT growth rate and net debt to EBITDA were encouraging signs. Taking the abovementioned factors together we do think Parkson Holdings Berhad'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. 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. For example, we've discovered 4 warning signs for Parkson Holdings Berhad (1 is concerning!) that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.