Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Pureprofile Ltd (ASX:PPL) does carry debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Pureprofile's Net Debt?
As you can see below, Pureprofile had AU$3.00m of debt at June 2021, down from AU$24.4m a year prior. However, its balance sheet shows it holds AU$3.62m in cash, so it actually has AU$621.7k net cash.
How Strong Is Pureprofile's Balance Sheet?
According to the last reported balance sheet, Pureprofile had liabilities of AU$10.8m due within 12 months, and liabilities of AU$4.86m due beyond 12 months. On the other hand, it had cash of AU$3.62m and AU$6.39m worth of receivables due within a year. So its liabilities total AU$5.64m more than the combination of its cash and short-term receivables.
Since publicly traded Pureprofile shares are worth a total of AU$77.0m, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Pureprofile boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Pureprofile'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.
Over 12 months, Pureprofile reported revenue of AU$30m, which is a gain of 24%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.
So How Risky Is Pureprofile?
Although Pureprofile had an earnings before interest and tax (EBIT) loss over the last twelve months, it made a statutory profit of AU$2.8m. So taking that on face value, and considering the cash, we don't think its very risky in the near term. The good news for Pureprofile shareholders is that its revenue growth is strong, making it easier to raise capital if need be. But we still think it's somewhat 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 4 warning signs for Pureprofile (2 can't be ignored) you should be aware of.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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.
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