Is Pan Hong Holdings Group (SGX:P36) Using Too Much 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.' 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 can see that Pan Hong Holdings Group Limited (SGX:P36) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Pan Hong Holdings Group

What Is Pan Hong Holdings Group's Debt?

As you can see below, Pan Hong Holdings Group had CN¥10.3m of debt at March 2021, down from CN¥23.0m a year prior. However, its balance sheet shows it holds CN¥397.9m in cash, so it actually has CN¥387.7m net cash.

How Strong Is Pan Hong Holdings Group's Balance Sheet?

According to the last reported balance sheet, Pan Hong Holdings Group had liabilities of CN¥677.3m due within 12 months, and liabilities of CN¥4.63m due beyond 12 months. Offsetting these obligations, it had cash of CN¥397.9m as well as receivables valued at CN¥43.2m due within 12 months. So its liabilities total CN¥240.8m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Pan Hong Holdings Group is worth CN¥580.7m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Pan Hong Holdings Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that Pan Hong Holdings Group grew its EBIT by 146% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. There's no doubt that we learn most about debt from the balance sheet. 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. Pan Hong Holdings Group may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Pan Hong Holdings Group's free cash flow amounted to 22% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

Although Pan Hong Holdings Group's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥387.7m. And we liked the look of last year's 146% year-on-year EBIT growth. So we are not troubled with Pan Hong Holdings Group's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Pan Hong Holdings Group (of which 1 can't be ignored!) you should know about.

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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