Stock Analysis

These 4 Measures Indicate That Pizu Group Holdings (HKG:8053) Is Using Debt Extensively

SEHK:8053
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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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Pizu Group Holdings Limited (HKG:8053) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Pizu Group Holdings

How Much Debt Does Pizu Group Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2021 Pizu Group Holdings had CN¥1.01b of debt, an increase on CN¥322.7m, over one year. However, it also had CN¥431.5m in cash, and so its net debt is CN¥577.0m.

debt-equity-history-analysis
SEHK:8053 Debt to Equity History January 18th 2022

How Strong Is Pizu Group Holdings' Balance Sheet?

The latest balance sheet data shows that Pizu Group Holdings had liabilities of CN¥1.06b due within a year, and liabilities of CN¥664.6m falling due after that. On the other hand, it had cash of CN¥431.5m and CN¥790.7m worth of receivables due within a year. So its liabilities total CN¥499.5m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Pizu Group Holdings is worth CN¥1.24b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Pizu Group Holdings has a low net debt to EBITDA ratio of only 1.3. And its EBIT covers its interest expense a whopping 23.9 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The modesty of its debt load may become crucial for Pizu Group Holdings if management cannot prevent a repeat of the 32% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Pizu Group Holdings will need earnings to service that debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Pizu Group Holdings produced sturdy free cash flow equating to 61% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Neither Pizu Group Holdings's ability to grow its EBIT nor its level of total liabilities gave us confidence in its ability to take on more debt. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. We think that Pizu Group Holdings's debt does make it a bit risky, after considering the aforementioned data points together. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 5 warning signs for Pizu Group Holdings that you should be aware of.

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.