David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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, People Infrastructure Ltd (ASX:PPE) does carry debt. But the more important question is: how much risk is that debt creating?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.
What Is People Infrastructure's Debt?
As you can see below, People Infrastructure had AU$19.5m of debt at December 2020, down from AU$35.1m a year prior. However, its balance sheet shows it holds AU$26.7m in cash, so it actually has AU$7.21m net cash.
How Strong Is People Infrastructure's Balance Sheet?
We can see from the most recent balance sheet that People Infrastructure had liabilities of AU$33.4m falling due within a year, and liabilities of AU$22.4m due beyond that. Offsetting this, it had AU$26.7m in cash and AU$44.3m in receivables that were due within 12 months. So it actually has AU$15.2m more liquid assets than total liabilities.
This short term liquidity is a sign that People Infrastructure could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that People Infrastructure has more cash than debt is arguably a good indication that it can manage its debt safely.
On top of that, People Infrastructure grew its EBIT by 61% over the last twelve months, and that growth will make it easier to handle its debt. 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 People Infrastructure 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While People Infrastructure 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 most recent three years, People Infrastructure recorded free cash flow worth 69% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While we empathize with investors who find debt concerning, you should keep in mind that People Infrastructure has net cash of AU$7.21m, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 61% over the last year. So we don't think People Infrastructure's use of debt is risky. 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 instance, we've identified 2 warning signs for People Infrastructure that you should be aware of.
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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