These 4 Measures Indicate That Prinx Chengshan (Cayman) Holding (HKG:1809) Is Using Debt Reasonably Well

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. As with many other companies Prinx Chengshan (Cayman) Holding Limited (HKG:1809) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Prinx Chengshan (Cayman) Holding

How Much Debt Does Prinx Chengshan (Cayman) Holding Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Prinx Chengshan (Cayman) Holding had CN¥665.2m of debt, an increase on CN¥357.0m, over one year. But it also has CN¥716.6m in cash to offset that, meaning it has CN¥51.5m net cash.

How Strong Is Prinx Chengshan (Cayman) Holding's Balance Sheet?

The latest balance sheet data shows that Prinx Chengshan (Cayman) Holding had liabilities of CN¥3.00b due within a year, and liabilities of CN¥705.8m falling due after that. On the other hand, it had cash of CN¥716.6m and CN¥1.57b worth of receivables due within a year. So its liabilities total CN¥1.43b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Prinx Chengshan (Cayman) Holding is worth CN¥4.93b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Prinx Chengshan (Cayman) Holding also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, Prinx Chengshan (Cayman) Holding grew its EBIT by 40% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Prinx Chengshan (Cayman) Holding's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Prinx Chengshan (Cayman) Holding 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. Over the last three years, Prinx Chengshan (Cayman) Holding saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

Although Prinx Chengshan (Cayman) Holding's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥51.5m. And it impressed us with its EBIT growth of 40% over the last year. So we are not troubled with Prinx Chengshan (Cayman) Holding'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. For instance, we've identified 2 warning signs for Prinx Chengshan (Cayman) Holding (1 makes us a bit uncomfortable) you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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