We Think Precious Dragon Technology Holdings (HKG:1861) Can Stay On Top Of Its Debt

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Precious Dragon Technology Holdings Limited (HKG:1861) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Precious Dragon Technology Holdings

How Much Debt Does Precious Dragon Technology Holdings Carry?

The image below, which you can click on for greater detail, shows that at December 2020 Precious Dragon Technology Holdings had debt of HK$67.8m, up from HK$40.0m in one year. However, it does have HK$169.4m in cash offsetting this, leading to net cash of HK$101.6m.

A Look At Precious Dragon Technology Holdings' Liabilities

We can see from the most recent balance sheet that Precious Dragon Technology Holdings had liabilities of HK$231.1m falling due within a year, and liabilities of HK$64.5m due beyond that. Offsetting these obligations, it had cash of HK$169.4m as well as receivables valued at HK$40.5m due within 12 months. So its liabilities total HK$85.7m more than the combination of its cash and short-term receivables.

Since publicly traded Precious Dragon Technology Holdings shares are worth a total of HK$1.03b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Precious Dragon Technology Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Precious Dragon Technology Holdings grew its EBIT by 119% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Precious Dragon Technology 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, a company can only pay off debt with cold hard cash, not accounting profits. Precious Dragon Technology 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. Looking at the most recent three years, Precious Dragon Technology Holdings recorded free cash flow of 38% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

We could understand if investors are concerned about Precious Dragon Technology Holdings's liabilities, but we can be reassured by the fact it has has net cash of HK$101.6m. And it impressed us with its EBIT growth of 119% over the last year. So we don't think Precious Dragon Technology Holdings's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for Precious Dragon Technology Holdings (2 shouldn't be ignored!) 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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This article by Simply Wall St is general in nature. 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.
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