These 4 Measures Indicate That Pico Far East Holdings (HKG:752) Is Using Debt Reasonably Well
The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. Importantly, Pico Far East Holdings Limited (HKG:752) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
Check out our latest analysis for Pico Far East Holdings
What Is Pico Far East Holdings's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of April 2019 Pico Far East Holdings had HK$487.8m of debt, an increase on HK$65.6m, over one year. But on the other hand it also has HK$1.15b in cash, leading to a HK$660.2m net cash position.
A Look At Pico Far East Holdings's Liabilities
According to the last reported balance sheet, Pico Far East Holdings had liabilities of HK$1.99b due within 12 months, and liabilities of HK$455.5m due beyond 12 months. On the other hand, it had cash of HK$1.15b and HK$1.70b worth of receivables due within a year. So it can boast HK$403.4m more liquid assets than total liabilities.
This short term liquidity is a sign that Pico Far East Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Pico Far East Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
But the other side of the story is that Pico Far East Holdings saw its EBIT decline by 3.4% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Pico Far East Holdings can strengthen its balance sheet over time. 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. Pico Far East Holdings 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. Looking at the most recent three years, Pico Far East Holdings recorded free cash flow of 38% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
Summing up
While we empathize with investors who find debt concerning, you should keep in mind that Pico Far East Holdings has net cash of HK$660.2m, as well as more liquid assets than liabilities. So we don't have any problem with Pico Far East Holdings's use of debt. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check Pico Far East Holdings's dividend history, without delay!
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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
