Is Pro-Pac Packaging (ASX:PPG) A Risky Investment?

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.' 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 Pro-Pac Packaging Limited (ASX:PPG) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Pro-Pac Packaging

What Is Pro-Pac Packaging's Debt?

The chart below, which you can click on for greater detail, shows that Pro-Pac Packaging had AU$19.8m in debt in December 2023; about the same as the year before. On the flip side, it has AU$5.37m in cash leading to net debt of about AU$14.5m.

How Strong Is Pro-Pac Packaging's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Pro-Pac Packaging had liabilities of AU$99.8m due within 12 months and liabilities of AU$27.4m due beyond that. Offsetting this, it had AU$5.37m in cash and AU$64.8m in receivables that were due within 12 months. So it has liabilities totalling AU$57.0m more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the AU$25.4m 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, Pro-Pac Packaging would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But it is Pro-Pac Packaging'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.

In the last year Pro-Pac Packaging had a loss before interest and tax, and actually shrunk its revenue by 11%, to AU$315m. That's not what we would hope to see.

Caveat Emptor

While Pro-Pac Packaging's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost a very considerable AU$6.4m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. For example, we would not want to see a repeat of last year's loss of AU$10m. In the meantime, we consider the stock to be risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Pro-Pac Packaging , 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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com