PPS International (Holdings) (HKG:8201) Seems To Use Debt Quite Sensibly

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. We note that PPS International (Holdings) Limited (HKG:8201) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for PPS International (Holdings)

What Is PPS International (Holdings)'s Net Debt?

As you can see below, PPS International (Holdings) had HK$21.9m of debt at December 2021, down from HK$32.8m a year prior. But it also has HK$76.8m in cash to offset that, meaning it has HK$54.9m net cash.

How Strong Is PPS International (Holdings)'s Balance Sheet?

Zooming in on the latest balance sheet data, we can see that PPS International (Holdings) had liabilities of HK$74.4m due within 12 months and liabilities of HK$1.21m due beyond that. Offsetting these obligations, it had cash of HK$76.8m as well as receivables valued at HK$140.3m due within 12 months. So it can boast HK$141.5m more liquid assets than total liabilities.

This excess liquidity is a great indication that PPS International (Holdings)'s balance sheet is almost as strong as Fort Knox. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that PPS International (Holdings) has more cash than debt is arguably a good indication that it can manage its debt safely.

Another good sign is that PPS International (Holdings) has been able to increase its EBIT by 21% in twelve months, making it easier to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since PPS International (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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. PPS International (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. Over the last three years, PPS International (Holdings) 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

While we empathize with investors who find debt concerning, the bottom line is that PPS International (Holdings) has net cash of HK$54.9m and plenty of liquid assets. And we liked the look of last year's 21% year-on-year EBIT growth. So is PPS International (Holdings)'s debt a risk? It doesn't seem so 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. We've identified 2 warning signs with PPS International (Holdings) (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.

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.