Prosper Construction Holdings (HKG:6816) Has A Pretty Healthy Balance Sheet

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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Prosper Construction Holdings Limited (HKG:6816) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Prosper Construction Holdings

What Is Prosper Construction Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2020 Prosper Construction Holdings had debt of HK$245.7m, up from HK$112.3m in one year. However, it does have HK$257.0m in cash offsetting this, leading to net cash of HK$11.2m.

How Strong Is Prosper Construction Holdings's Balance Sheet?

We can see from the most recent balance sheet that Prosper Construction Holdings had liabilities of HK$951.9m falling due within a year, and liabilities of HK$17.7m due beyond that. Offsetting these obligations, it had cash of HK$257.0m as well as receivables valued at HK$926.4m due within 12 months. So it actually has HK$213.8m more liquid assets than total liabilities.

This luscious liquidity implies that Prosper Construction Holdings's balance sheet is sturdy like a giant sequoia tree. On this basis we think its balance sheet is strong like a sleek panther or even a proud lion. Simply put, the fact that Prosper Construction Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

It is well worth noting that Prosper Construction Holdings's EBIT shot up like bamboo after rain, gaining 50% in the last twelve months. That'll make it easier to manage its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Prosper Construction 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. Prosper Construction 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. During the last three years, Prosper Construction Holdings burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

While it is always sensible to investigate a company's debt, in this case Prosper Construction Holdings has HK$11.2m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 50% over the last year. So we don't have any problem with Prosper Construction Holdings's use of debt. 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. For instance, we've identified 6 warning signs for Prosper Construction Holdings (3 can't be ignored) 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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