Is Pearl Polymers (NSE:PEARLPOLY) A Risky Investment?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We note that Pearl Polymers Limited (NSE:PEARLPOLY) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

View our latest analysis for Pearl Polymers

What Is Pearl Polymers's Debt?

As you can see below, at the end of September 2020, Pearl Polymers had ₹313.6m of debt, up from ₹268.6m a year ago. Click the image for more detail. However, because it has a cash reserve of ₹27.3m, its net debt is less, at about ₹286.3m.

How Strong Is Pearl Polymers' Balance Sheet?

We can see from the most recent balance sheet that Pearl Polymers had liabilities of ₹585.3m falling due within a year, and liabilities of ₹89.4m due beyond that. On the other hand, it had cash of ₹27.3m and ₹267.4m worth of receivables due within a year. So it has liabilities totalling ₹379.9m more than its cash and near-term receivables, combined.

When you consider that this deficiency exceeds the company's ₹263.5m 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. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Pearl Polymers will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

In the last year Pearl Polymers had a loss before interest and tax, and actually shrunk its revenue by 25%, to ₹1.1b. That makes us nervous, to say the least.

Caveat Emptor

While Pearl Polymers's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping ₹85m. Considering that alongside the liabilities mentioned above make us nervous about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through ₹1.5m in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Pearl Polymers you should be aware of, and 2 of them make us uncomfortable.

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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This article by Simply Wall St is general in nature. 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.
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