Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. Importantly, Pan-United Corporation Ltd (SGX:P52) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for Pan-United
How Much Debt Does Pan-United Carry?
You can click the graphic below for the historical numbers, but it shows that Pan-United had S$87.4m of debt in December 2020, down from S$106.9m, one year before. However, it also had S$67.6m in cash, and so its net debt is S$19.8m.
A Look At Pan-United's Liabilities
Zooming in on the latest balance sheet data, we can see that Pan-United had liabilities of S$133.6m due within 12 months and liabilities of S$65.7m due beyond that. On the other hand, it had cash of S$67.6m and S$116.8m worth of receivables due within a year. So its liabilities total S$14.9m more than the combination of its cash and short-term receivables.
Of course, Pan-United has a market capitalization of S$221.0m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Pan-United has a very low debt to EBITDA ratio of 0.69 so it is strange to see weak interest coverage, with last year's EBIT being only 1.6 times the interest expense. So one way or the other, it's clear the debt levels are not trivial. Shareholders should be aware that Pan-United's EBIT was down 84% last year. 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-United'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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Pan-United actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Our View
Pan-United's EBIT growth rate was a real negative on this analysis, as was its interest cover. But its conversion of EBIT to free cash flow was significantly redeeming. Looking at all this data makes us feel a little cautious about Pan-United's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 4 warning signs we've spotted with Pan-United (including 2 which make us uncomfortable) .
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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About SGX:P52
Pan-United
An investment holding company, engages in the concrete and logistics businesses in Singapore and internationally.
Flawless balance sheet and undervalued.