Is Pearl River Holdings (CVE:PRH) Using Too Much Debt?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. Importantly, Pearl River Holdings Limited (CVE:PRH) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Pearl River Holdings

What Is Pearl River Holdings's Net Debt?

As you can see below, at the end of June 2021, Pearl River Holdings had CN¥14.8m of debt, up from CN¥11.9m a year ago. Click the image for more detail. But it also has CN¥41.1m in cash to offset that, meaning it has CN¥26.3m net cash.

A Look At Pearl River Holdings' Liabilities

The latest balance sheet data shows that Pearl River Holdings had liabilities of CN¥56.2m due within a year, and liabilities of CN¥19.7m falling due after that. Offsetting these obligations, it had cash of CN¥41.1m as well as receivables valued at CN¥56.4m due within 12 months. So it actually has CN¥21.6m more liquid assets than total liabilities.

This luscious liquidity implies that Pearl River Holdings' balance sheet is sturdy like a giant sequoia tree. 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!

In addition to that, we're happy to report that Pearl River Holdings has boosted its EBIT by 46%, thus reducing the spectre of future debt repayments. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Pearl River Holdings 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. During the last three years, Pearl River Holdings produced sturdy free cash flow equating to 71% 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.

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¥26.3m, as well as more liquid assets than liabilities. And we liked the look of last year's 46% year-on-year EBIT growth. At the end of the day we're not concerned about Pearl River Holdings's debt. 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. Be aware that Pearl River Holdings is showing 3 warning signs in our investment analysis , you should know about...

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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