Is Peter Warren Automotive Holdings (ASX:PWR) A Risky Investment?

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.' 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. We can see that Peter Warren Automotive Holdings Limited (ASX:PWR) does use debt in its business. But should shareholders be worried about its use of debt?

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When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Peter Warren Automotive Holdings's Debt?

The image below, which you can click on for greater detail, shows that at December 2024 Peter Warren Automotive Holdings had debt of AU$529.8m, up from AU$481.0m in one year. However, because it has a cash reserve of AU$22.7m, its net debt is less, at about AU$507.1m.

A Look At Peter Warren Automotive Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that Peter Warren Automotive Holdings had liabilities of AU$596.5m due within 12 months and liabilities of AU$305.8m due beyond that. Offsetting this, it had AU$22.7m in cash and AU$89.1m in receivables that were due within 12 months. So it has liabilities totalling AU$790.5m more than its cash and near-term receivables, combined.

This deficit casts a shadow over the AU$283.8m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Peter Warren Automotive Holdings would probably need a major re-capitalization if its creditors were to demand repayment.

See our latest analysis for Peter Warren Automotive Holdings

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Peter Warren Automotive Holdings shareholders face the double whammy of a high net debt to EBITDA ratio (5.8), and fairly weak interest coverage, since EBIT is just 1.6 times the interest expense. The debt burden here is substantial. Even worse, Peter Warren Automotive Holdings saw its EBIT tank 25% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Peter Warren Automotive Holdings's ability to maintain a healthy balance sheet going forward. 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 company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Peter Warren Automotive Holdings produced sturdy free cash flow equating to 64% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

On the face of it, Peter Warren Automotive Holdings's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. After considering the datapoints discussed, we think Peter Warren Automotive Holdings has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Peter Warren Automotive Holdings you should be aware of, and 1 of them shouldn't be ignored.

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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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.