These 4 Measures Indicate That Praemium (ASX:PPS) Is Using Debt Reasonably Well

By
Simply Wall St
Published
November 06, 2021
ASX:PPS
Source: Shutterstock

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Praemium Limited (ASX:PPS) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Praemium

How Much Debt Does Praemium Carry?

As you can see below, at the end of June 2021, Praemium had AU$13.6m of debt, up from none a year ago. Click the image for more detail. But it also has AU$26.7m in cash to offset that, meaning it has AU$13.1m net cash.

debt-equity-history-analysis
ASX:PPS Debt to Equity History November 6th 2021

How Healthy Is Praemium's Balance Sheet?

According to the last reported balance sheet, Praemium had liabilities of AU$19.8m due within 12 months, and liabilities of AU$11.9m due beyond 12 months. On the other hand, it had cash of AU$26.7m and AU$7.79m worth of receivables due within a year. So it can boast AU$2.86m more liquid assets than total liabilities.

This state of affairs indicates that Praemium's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the AU$796.1m company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Praemium boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Praemium if management cannot prevent a repeat of the 66% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Praemium can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Praemium 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. Looking at the most recent three years, Praemium recorded free cash flow of 38% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case Praemium has AU$13.1m in net cash and a decent-looking balance sheet. So we are not troubled with Praemium's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Be aware that Praemium is showing 3 warning signs in our investment analysis , you should know about...

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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