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 can see that PSP Projects Limited (NSE:PSPPROJECT) does use debt in its business. But the real question is whether this debt is making the company risky.
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. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company’s use of debt, we first look at cash and debt together.
What Is PSP Projects’s Net Debt?
The image below, which you can click on for greater detail, shows that at September 2019 PSP Projects had debt of ₹752.9m, up from ₹310.7m in one year. But it also has ₹2.89b in cash to offset that, meaning it has ₹2.14b net cash.
How Strong Is PSP Projects’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that PSP Projects had liabilities of ₹4.53b due within 12 months and liabilities of ₹2.18m due beyond that. On the other hand, it had cash of ₹2.89b and ₹1.85b worth of receivables due within a year. So it can boast ₹206.8m more liquid assets than total liabilities.
Having regard to PSP Projects’s size, it seems that its liquid assets are well balanced with its total liabilities. So while it’s hard to imagine that the ₹17.8b company is struggling for cash, we still think it’s worth monitoring its balance sheet. Succinctly put, PSP Projects boasts net cash, so it’s fair to say it does not have a heavy debt load!
On top of that, PSP Projects grew its EBIT by 39% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine PSP Projects’s ability to maintain a healthy balance sheet going forward. 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. PSP Projects 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 three years, PSP Projects recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.
While we empathize with investors who find debt concerning, you should keep in mind that PSP Projects has net cash of ₹2.14b, as well as more liquid assets than liabilities. And we liked the look of last year’s 39% year-on-year EBIT growth. So we don’t have any problem with PSP Projects’s use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet – far from it. Case in point: We’ve spotted 2 warning signs for PSP Projects you should be aware of, and 1 of them shouldn’t be ignored.
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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