Is Pan-International Industrial (TPE:2328) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We can see that Pan-International Industrial Corp. (TPE:2328) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.

See our latest analysis for Pan-International Industrial

What Is Pan-International Industrial's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Pan-International Industrial had NT$1.31b of debt in September 2020, down from NT$1.87b, one year before. But it also has NT$6.86b in cash to offset that, meaning it has NT$5.55b net cash.

A Look At Pan-International Industrial's Liabilities

The latest balance sheet data shows that Pan-International Industrial had liabilities of NT$7.26b due within a year, and liabilities of NT$480.5m falling due after that. Offsetting these obligations, it had cash of NT$6.86b as well as receivables valued at NT$5.16b due within 12 months. So it can boast NT$4.28b more liquid assets than total liabilities.

This surplus suggests that Pan-International Industrial is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Succinctly put, Pan-International Industrial boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Pan-International Industrial if management cannot prevent a repeat of the 41% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Pan-International Industrial will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Pan-International Industrial 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 last three years, Pan-International Industrial actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to investigate a company's debt, in this case Pan-International Industrial has NT$5.55b in net cash and a decent-looking balance sheet. The cherry on top was that in converted 138% of that EBIT to free cash flow, bringing in NT$2.3b. So we don't think Pan-International Industrial's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Pan-International Industrial , and understanding them should be part of your investment process.

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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