Does Pan Hong Holdings Group (SGX:P36) Have A Healthy Balance Sheet?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Pan Hong Holdings Group Limited (SGX:P36) does use debt in its business. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

See our latest analysis for Pan Hong Holdings Group

What Is Pan Hong Holdings Group's Debt?

You can click the graphic below for the historical numbers, but it shows that Pan Hong Holdings Group had CN¥102.8m of debt in March 2024, down from CN¥315.6m, one year before. However, it also had CN¥93.1m in cash, and so its net debt is CN¥9.65m.

A Look At Pan Hong Holdings Group's Liabilities

Zooming in on the latest balance sheet data, we can see that Pan Hong Holdings Group had liabilities of CN¥1.10b due within 12 months and liabilities of CN¥43.9m due beyond that. On the other hand, it had cash of CN¥93.1m and CN¥100.7m worth of receivables due within a year. So its liabilities total CN¥946.4m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CN¥195.5m 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. After all, Pan Hong Holdings Group would likely require a major re-capitalisation if it had to pay its creditors today.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). 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).

Pan Hong Holdings Group has net debt of just 0.15 times EBITDA, suggesting it could ramp leverage without breaking a sweat. But the really cool thing is that it actually managed to receive more interest than it paid, over the last year. So there's no doubt this company can take on debt while staying cool as a cucumber. It was also good to see that despite losing money on the EBIT line last year, Pan Hong Holdings Group turned things around in the last 12 months, delivering and EBIT of CN¥60m. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Pan Hong Holdings Group will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Happily for any shareholders, Pan Hong Holdings Group actually produced more free cash flow than EBIT over the last year. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

We feel some trepidation about Pan Hong Holdings Group's difficulty level of total liabilities, but we've got positives to focus on, too. For example, its interest cover and conversion of EBIT to free cash flow give us some confidence in its ability to manage its debt. Looking at all the angles mentioned above, it does seem to us that Pan Hong Holdings Group is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Pan Hong Holdings Group (1 makes us a bit uncomfortable) you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com