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. Importantly, Pacific Hospital Supply Co., Ltd (GTSM:4126) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Pacific Hospital Supply's Debt?
As you can see below, Pacific Hospital Supply had NT$400.0m of debt at December 2020, down from NT$550.0m a year prior. But on the other hand it also has NT$616.9m in cash, leading to a NT$216.9m net cash position.
How Strong Is Pacific Hospital Supply's Balance Sheet?
The latest balance sheet data shows that Pacific Hospital Supply had liabilities of NT$538.1m due within a year, and liabilities of NT$795.8m falling due after that. Offsetting these obligations, it had cash of NT$616.9m as well as receivables valued at NT$170.1m due within 12 months. So its liabilities total NT$546.9m more than the combination of its cash and short-term receivables.
Since publicly traded Pacific Hospital Supply shares are worth a total of NT$5.38b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Pacific Hospital Supply boasts net cash, so it's fair to say it does not have a heavy debt load!
Also positive, Pacific Hospital Supply grew its EBIT by 27% in the last year, and that should make it easier to pay down debt, going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Pacific Hospital Supply's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Pacific Hospital Supply 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. Over the most recent three years, Pacific Hospital Supply recorded free cash flow worth 76% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While Pacific Hospital Supply does have more liabilities than liquid assets, it also has net cash of NT$216.9m. And it impressed us with its EBIT growth of 27% over the last year. So is Pacific Hospital Supply's debt a risk? It doesn't seem so to us. 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 2 warning signs for Pacific Hospital Supply (1 is a bit unpleasant) you should be aware of.
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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