Does Paiho Shih Holdings (TPE:8404) Have A Healthy Balance Sheet?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Paiho Shih Holdings Corporation (TPE:8404) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

Check out our latest analysis for Paiho Shih Holdings

What Is Paiho Shih Holdings's Net Debt?

The chart below, which you can click on for greater detail, shows that Paiho Shih Holdings had NT$7.48b in debt in September 2020; about the same as the year before. However, it also had NT$4.74b in cash, and so its net debt is NT$2.74b.

How Strong Is Paiho Shih Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Paiho Shih Holdings had liabilities of NT$8.98b due within 12 months and liabilities of NT$2.93b due beyond that. On the other hand, it had cash of NT$4.74b and NT$1.52b worth of receivables due within a year. So it has liabilities totalling NT$5.64b more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of NT$8.82b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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.

Paiho Shih Holdings's net debt of 1.7 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 10.0 times interest expense) certainly does not do anything to dispel this impression. Paiho Shih Holdings's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. 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 Paiho Shih Holdings'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, Paiho Shih Holdings saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

Mulling over Paiho Shih Holdings's attempt at converting EBIT to free cash flow, we're certainly not enthusiastic. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Paiho Shih Holdings stock a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. 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. For example Paiho Shih Holdings has 3 warning signs (and 1 which makes us a bit uncomfortable) we think 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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