Is Pegavision (TPE:6491) Using Too Much Debt?

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 Pegavision Corporation (TPE:6491) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Pegavision

How Much Debt Does Pegavision Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Pegavision had NT$382.6m of debt, an increase on NT$128.9m, over one year. However, its balance sheet shows it holds NT$1.81b in cash, so it actually has NT$1.43b net cash.

How Strong Is Pegavision's Balance Sheet?

The latest balance sheet data shows that Pegavision had liabilities of NT$1.72b due within a year, and liabilities of NT$103.4m falling due after that. Offsetting this, it had NT$1.81b in cash and NT$578.4m in receivables that were due within 12 months. So it actually has NT$570.8m more liquid assets than total liabilities.

This short term liquidity is a sign that Pegavision could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Pegavision has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Pegavision grew its EBIT by 45% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Pegavision'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Pegavision 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. Over the last three years, Pegavision saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Pegavision has net cash of NT$1.43b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 45% over the last year. So we don't have any problem with Pegavision's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example - Pegavision has 1 warning sign we think 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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