We Think Pearl River Holdings (CVE:PRH) Can Manage Its Debt With Ease

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.' 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?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Pearl River Holdings

How Much Debt Does Pearl River Holdings Carry?

As you can see below, at the end of December 2020, Pearl River Holdings had CN¥10.3m of debt, up from CN¥8.05m a year ago. Click the image for more detail. But on the other hand it also has CN¥52.0m in cash, leading to a CN¥41.7m net cash position.

How Strong Is Pearl River Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Pearl River Holdings had liabilities of CN¥58.3m due within 12 months and liabilities of CN¥24.9m due beyond that. Offsetting this, it had CN¥52.0m in cash and CN¥69.1m in receivables that were due within 12 months. So it actually has CN¥37.9m 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. On this view, lenders should feel as safe as the beloved of a black-belt karate master. 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.

Even more impressive was the fact that Pearl River Holdings grew its EBIT by 144% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. 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 when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

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¥41.7m in net cash and a strong balance sheet. And it impressed us with free cash flow of CN¥24m, being 147% of its EBIT. The bottom line is that Pearl River Holdings's use of debt is absolutely fine. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Pearl River Holdings has 2 warning signs we think you should be aware of.

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. 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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