Pudumjee Paper Products (NSE:PDMJEPAPER) 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.' 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. Importantly, Pudumjee Paper Products Limited (NSE:PDMJEPAPER) does carry debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

See our latest analysis for Pudumjee Paper Products

How Much Debt Does Pudumjee Paper Products Carry?

You can click the graphic below for the historical numbers, but it shows that Pudumjee Paper Products had ₹311.5m of debt in September 2020, down from ₹585.1m, one year before. But on the other hand it also has ₹584.6m in cash, leading to a ₹273.1m net cash position.

How Strong Is Pudumjee Paper Products's Balance Sheet?

The latest balance sheet data shows that Pudumjee Paper Products had liabilities of ₹1.04b due within a year, and liabilities of ₹859.2m falling due after that. On the other hand, it had cash of ₹584.6m and ₹476.4m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₹841.3m.

Pudumjee Paper Products has a market capitalization of ₹2.16b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Pudumjee Paper Products boasts net cash, so it's fair to say it does not have a heavy debt load!

Another good sign is that Pudumjee Paper Products has been able to increase its EBIT by 21% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Pudumjee Paper Products'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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Pudumjee Paper Products 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. Over the most recent three years, Pudumjee Paper Products recorded free cash flow worth 59% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing up

While Pudumjee Paper Products does have more liabilities than liquid assets, it also has net cash of ₹273.1m. And we liked the look of last year's 21% year-on-year EBIT growth. So we are not troubled with Pudumjee Paper Products's debt use. 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. Take risks, for example - Pudumjee Paper Products has 3 warning signs we think you should be aware of.

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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