Pro-Hawk (GTSM:8083) Has A Pretty Healthy Balance Sheet

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 Pro-Hawk Corporation (GTSM:8083) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Pro-Hawk

What Is Pro-Hawk's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2020 Pro-Hawk had debt of NT$490.0m, up from NT$330.0m in one year. However, it does have NT$26.1m in cash offsetting this, leading to net debt of about NT$463.9m.

A Look At Pro-Hawk's Liabilities

According to the last reported balance sheet, Pro-Hawk had liabilities of NT$792.2m due within 12 months, and liabilities of NT$9.32m due beyond 12 months. On the other hand, it had cash of NT$26.1m and NT$679.9m worth of receivables due within a year. So it has liabilities totalling NT$95.6m more than its cash and near-term receivables, combined.

Having regard to Pro-Hawk's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the NT$6.57b company is struggling for cash, we still think it's worth monitoring its balance sheet.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Pro-Hawk has a low net debt to EBITDA ratio of only 0.84. And its EBIT easily covers its interest expense, being 156 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Another good sign is that Pro-Hawk has been able to increase its EBIT by 28% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Pro-Hawk 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Pro-Hawk recorded free cash flow of 36% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

The good news is that Pro-Hawk's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But truth be told we feel its conversion of EBIT to free cash flow does undermine this impression a bit. Looking at the bigger picture, we think Pro-Hawk's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Pro-Hawk you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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This article by Simply Wall St is general in nature. 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.
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