Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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 Pantoro Limited (ASX:PNR) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Pantoro Carry?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 Pantoro had AU$743.7k of debt, an increase on AU$621.0k, over one year. But on the other hand it also has AU$53.7m in cash, leading to a AU$53.0m net cash position.
How Strong Is Pantoro's Balance Sheet?
We can see from the most recent balance sheet that Pantoro had liabilities of AU$16.1m falling due within a year, and liabilities of AU$5.21m due beyond that. Offsetting these obligations, it had cash of AU$53.7m as well as receivables valued at AU$1.21m due within 12 months. So it can boast AU$33.6m more liquid assets than total liabilities.
It's good to see that Pantoro has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Pantoro has more cash than debt is arguably a good indication that it can manage its debt safely.
It is just as well that Pantoro's load is not too heavy, because its EBIT was down 94% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Pantoro'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. While Pantoro 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. During the last three years, Pantoro burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
While it is always sensible to investigate a company's debt, in this case Pantoro has AU$53.0m in net cash and a decent-looking balance sheet. So we don't have any problem with Pantoro's use of debt. Over time, share prices tend to follow earnings per share, so if you're interested in Pantoro, you may well want to click here to check an interactive graph of its earnings per share history.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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If you spot an error that warrants correction, please contact the editor at email@example.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.