Stock Analysis

Is Pizu Group Holdings (HKG:8053) Using Too Much Debt?

SEHK:8053
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David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We note that Pizu Group Holdings Limited (HKG:8053) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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.

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What Is Pizu Group Holdings's Debt?

The image below, which you can click on for greater detail, shows that Pizu Group Holdings had debt of CN¥322.7m at the end of September 2020, a reduction from CN¥417.6m over a year. However, it also had CN¥146.1m in cash, and so its net debt is CN¥176.7m.

debt-equity-history-analysis
SEHK:8053 Debt to Equity History March 24th 2021

How Healthy Is Pizu Group Holdings' Balance Sheet?

According to the last reported balance sheet, Pizu Group Holdings had liabilities of CN¥558.9m due within 12 months, and liabilities of CN¥60.7m due beyond 12 months. Offsetting these obligations, it had cash of CN¥146.1m as well as receivables valued at CN¥1.23b due within 12 months. So it can boast CN¥753.8m more liquid assets than total liabilities.

This excess liquidity is a great indication that Pizu Group 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.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Pizu Group Holdings's net debt is only 0.31 times its EBITDA. And its EBIT easily covers its interest expense, being 88.2 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Another good sign is that Pizu Group Holdings has been able to increase its EBIT by 23% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Pizu Group Holdings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Pizu Group Holdings's free cash flow amounted to 34% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

Pizu Group Holdings's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its conversion of EBIT to free cash flow. Considering this range of factors, it seems to us that Pizu Group Holdings is quite prudent with its debt, and the risks seem well managed. So the balance sheet looks pretty healthy, to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Pizu Group Holdings that you should be aware of before investing here.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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