Prosper One International Holdings (HKG:1470) Seems To Use Debt Quite Sensibly

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Prosper One International Holdings Company Limited (HKG:1470) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Prosper One International Holdings

How Much Debt Does Prosper One International Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that as of April 2023 Prosper One International Holdings had HK$46.1m of debt, an increase on HK$39.7m, over one year. However, its balance sheet shows it holds HK$126.2m in cash, so it actually has HK$80.1m net cash.

How Strong Is Prosper One International Holdings' Balance Sheet?

According to the balance sheet data, Prosper One International Holdings had liabilities of HK$184.7m due within 12 months, but no longer term liabilities. On the other hand, it had cash of HK$126.2m and HK$131.0k worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$58.4m.

When you consider that this deficiency exceeds the company's HK$52.8m 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. Prosper One International Holdings boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

Although Prosper One International Holdings made a loss at the EBIT level, last year, it was also good to see that it generated HK$1.7m in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Prosper One 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, a company can only pay off debt with cold hard cash, not accounting profits. Prosper One 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 year, Prosper One International Holdings actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While Prosper One International Holdings does have more liabilities than liquid assets, it also has net cash of HK$80.1m. The cherry on top was that in converted 2,186% of that EBIT to free cash flow, bringing in HK$38m. So we are not troubled with Prosper One International Holdings's debt use. 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. We've identified 2 warning signs with Prosper One International Holdings (at least 1 which makes us a bit uncomfortable) , and understanding them should be part of your investment process.

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.