PSP Projects (NSE:PSPPROJECT) Takes On Some Risk With Its Use Of Debt

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that PSP Projects Limited (NSE:PSPPROJECT) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. 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.

See our latest analysis for PSP Projects

What Is PSP Projects's Net Debt?

As you can see below, at the end of September 2020, PSP Projects had ₹1.18b of debt, up from ₹752.9m a year ago. Click the image for more detail. But on the other hand it also has ₹2.92b in cash, leading to a ₹1.75b net cash position.

A Look At PSP Projects' Liabilities

Zooming in on the latest balance sheet data, we can see that PSP Projects had liabilities of ₹4.18b due within 12 months and liabilities of ₹39.9m due beyond that. On the other hand, it had cash of ₹2.92b and ₹2.10b worth of receivables due within a year. So it can boast ₹810.6m more liquid assets than total liabilities.

This surplus suggests that PSP Projects has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that PSP Projects has more cash than debt is arguably a good indication that it can manage its debt safely.

It is just as well that PSP Projects's load is not too heavy, because its EBIT was down 41% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if PSP Projects can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While PSP Projects has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, PSP Projects burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that PSP Projects has net cash of ₹1.75b, as well as more liquid assets than liabilities. So although we see some areas for improvement, we're not too worried about PSP Projects's balance sheet. 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. To that end, you should be aware of the 2 warning signs we've spotted with PSP Projects .

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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