These 4 Measures Indicate That Pan Hong Holdings Group (SGX:P36) Is Using Debt Reasonably Well

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. Importantly, Pan Hong Holdings Group Limited (SGX:P36) does carry debt. 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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Pan Hong Holdings Group

How Much Debt Does Pan Hong Holdings Group Carry?

The image below, which you can click on for greater detail, shows that Pan Hong Holdings Group had debt of CN¥14.9m at the end of September 2020, a reduction from CN¥48.3m over a year. However, its balance sheet shows it holds CN¥531.9m in cash, so it actually has CN¥517.0m net cash.

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¥788.8m due within 12 months and liabilities of CN¥4.72m due beyond that. Offsetting these obligations, it had cash of CN¥531.9m as well as receivables valued at CN¥18.1m due within 12 months. So its liabilities total CN¥243.5m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of CN¥380.6m, so it does suggest shareholders should keep an eye on Pan Hong Holdings Group's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. 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.

On top of that, Pan Hong Holdings Group grew its EBIT by 47% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Pan Hong Holdings Group's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Pan Hong Holdings Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Considering the last two years, Pan Hong Holdings Group actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing up

While Pan Hong Holdings Group does have more liabilities than liquid assets, it also has net cash of CN¥517.0m. And it impressed us with its EBIT growth of 47% over the last year. So we don't have any problem with Pan Hong Holdings Group's use of debt. 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. For instance, we've identified 2 warning signs for Pan Hong Holdings Group that you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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