Is Pacific Construction (TPE:2506) Using Debt Sensibly?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Pacific Construction Co., Ltd (TPE:2506) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Pacific Construction

What Is Pacific Construction's Debt?

As you can see below, Pacific Construction had NT$4.38b of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. However, it also had NT$765.0m in cash, and so its net debt is NT$3.62b.

How Strong Is Pacific Construction's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Pacific Construction had liabilities of NT$5.36b due within 12 months and liabilities of NT$2.22b due beyond that. On the other hand, it had cash of NT$765.0m and NT$141.1m worth of receivables due within a year. So its liabilities total NT$6.68b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the NT$3.55b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Pacific Construction would likely require a major re-capitalisation if it had to pay its creditors today. There's no doubt that we learn most about debt from the balance sheet. But it is Pacific Construction'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.

Over 12 months, Pacific Construction made a loss at the EBIT level, and saw its revenue drop to NT$848m, which is a fall of 46%. That makes us nervous, to say the least.

Caveat Emptor

Not only did Pacific Construction's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at NT$174m. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through NT$7.2m in negative free cash flow over the last year. That means it's on the risky side of things. 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 example, we've discovered 2 warning signs for Pacific Construction that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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