Is PuraPharm (HKG:1498) A Risky Investment?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 PuraPharm Corporation Limited (HKG:1498) makes use of debt. But the more important question is: how much risk is that debt creating?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for PuraPharm

What Is PuraPharm's Debt?

The chart below, which you can click on for greater detail, shows that PuraPharm had HK$419.9m in debt in June 2023; about the same as the year before. However, it does have HK$76.6m in cash offsetting this, leading to net debt of about HK$343.2m.

How Strong Is PuraPharm's Balance Sheet?

The latest balance sheet data shows that PuraPharm had liabilities of HK$650.3m due within a year, and liabilities of HK$79.7m falling due after that. Offsetting these obligations, it had cash of HK$76.6m as well as receivables valued at HK$84.6m due within 12 months. So its liabilities total HK$568.9m more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of HK$466.2m, we think shareholders really should watch PuraPharm's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. 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 PuraPharm 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.

Over 12 months, PuraPharm made a loss at the EBIT level, and saw its revenue drop to HK$412m, which is a fall of 30%. To be frank that doesn't bode well.

Caveat Emptor

While PuraPharm's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping HK$77m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. For example, we would not want to see a repeat of last year's loss of HK$118m. In the meantime, we consider the stock to be risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for PuraPharm (of which 1 is a bit concerning!) you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.