Pearl River Holdings (CVE:PRH) Could Easily Take On More Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We can see that Pearl River Holdings Limited (CVE:PRH) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Pearl River Holdings

How Much Debt Does Pearl River Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Pearl River Holdings had CN¥12.6m of debt, an increase on CN¥7.10m, over one year. However, it does have CN¥54.6m in cash offsetting this, leading to net cash of CN¥42.0m.

How Healthy Is Pearl River Holdings' Balance Sheet?

We can see from the most recent balance sheet that Pearl River Holdings had liabilities of CN¥72.6m falling due within a year, and liabilities of CN¥21.8m due beyond that. On the other hand, it had cash of CN¥54.6m and CN¥53.3m worth of receivables due within a year. So it actually has CN¥13.4m more liquid assets than total liabilities.

It's good to see that Pearl River Holdings has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Pearl River Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

Notably, Pearl River Holdings's EBIT launched higher than Elon Musk, gaining a whopping 1,068% on last year. There's no doubt that we learn most about debt from the balance sheet. 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 company can only pay off debt with cold hard cash, not accounting profits. 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. Happily for any shareholders, Pearl River Holdings actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to investigate a company's debt, in this case Pearl River Holdings has CN¥42.0m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 198% of that EBIT to free cash flow, bringing in CN¥24m. So is Pearl River Holdings's debt a risk? It doesn't seem so to us. 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. Be aware that Pearl River Holdings is showing 2 warning signs in our investment analysis , you should know about...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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This article by Simply Wall St is general in nature. 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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