PuraPharm (HKG:1498) Has Debt But No Earnings; Should You Worry?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 can see that PuraPharm Corporation Limited (HKG:1498) does use debt in its business. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for PuraPharm

What Is PuraPharm's Debt?

The image below, which you can click on for greater detail, shows that PuraPharm had debt of HK$412.9m at the end of June 2022, a reduction from HK$475.2m over a year. However, because it has a cash reserve of HK$75.1m, its net debt is less, at about HK$337.9m.

How Strong Is PuraPharm's Balance Sheet?

According to the last reported balance sheet, PuraPharm had liabilities of HK$599.2m due within 12 months, and liabilities of HK$128.5m due beyond 12 months. Offsetting these obligations, it had cash of HK$75.1m as well as receivables valued at HK$174.1m due within 12 months. So its liabilities total HK$478.6m more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's HK$470.1m market capitalization, you might well be inclined to review the balance sheet intently. 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. There's no doubt that we learn most about debt from the balance sheet. But it is PuraPharm's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, PuraPharm made a loss at the EBIT level, and saw its revenue drop to HK$588m, which is a fall of 5.9%. We would much prefer see growth.

Caveat Emptor

Over the last twelve months PuraPharm produced an earnings before interest and tax (EBIT) loss. Indeed, it lost HK$16m at the EBIT level. Considering that alongside the liabilities mentioned above make us nervous about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. It's fair to say the loss of HK$174m didn't encourage us either; we'd like to see a profit. And until that time we think this is a risky stock. 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. To that end, you should learn about the 2 warning signs we've spotted with PuraPharm (including 1 which is a bit unpleasant) .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.