Is Pearl River Holdings (CVE:PRH) A Risky Investment?

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.' 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 Pearl River Holdings Limited (CVE:PRH) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Pearl River Holdings

What Is Pearl River Holdings's Debt?

The image below, which you can click on for greater detail, shows that Pearl River Holdings had debt of CN¥11.0m at the end of March 2022, a reduction from CN¥15.0m over a year. But it also has CN¥39.1m in cash to offset that, meaning it has CN¥28.1m net cash.

How Healthy Is Pearl River Holdings' Balance Sheet?

The latest balance sheet data shows that Pearl River Holdings had liabilities of CN¥82.0m due within a year, and liabilities of CN¥3.40m falling due after that. On the other hand, it had cash of CN¥39.1m and CN¥64.8m worth of receivables due within a year. So it can boast CN¥18.5m more liquid assets than total liabilities.

This excess liquidity is a great indication that Pearl River Holdings' balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Pearl River Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Importantly, Pearl River Holdings's EBIT fell a jaw-dropping 51% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Pearl River Holdings's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Pearl River Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, Pearl River Holdings recorded free cash flow worth 72% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Pearl River Holdings has net cash of CN¥28.1m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥2.6m, being 72% of its EBIT. So we don't think Pearl River Holdings's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Pearl River Holdings is showing 3 warning signs in our investment analysis , and 2 of those don't sit too well with us...

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.

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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.