Is Prime Focus (NSE:PFOCUS) Using Too Much Debt?

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 Prime Focus Limited (NSE:PFOCUS) does use debt in its business. But is this debt a concern to shareholders?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Prime Focus

How Much Debt Does Prime Focus Carry?

As you can see below, at the end of September 2024, Prime Focus had ₹39.8b of debt, up from ₹35.8b a year ago. Click the image for more detail. On the flip side, it has ₹4.38b in cash leading to net debt of about ₹35.4b.

How Strong Is Prime Focus' Balance Sheet?

According to the last reported balance sheet, Prime Focus had liabilities of ₹27.9b due within 12 months, and liabilities of ₹39.0b due beyond 12 months. Offsetting this, it had ₹4.38b in cash and ₹5.13b in receivables that were due within 12 months. So it has liabilities totalling ₹57.3b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the ₹38.2b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. After all, Prime Focus would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. But it is Prime Focus's earnings that will influence how the balance sheet holds up in the future. 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 Prime Focus had a loss before interest and tax, and actually shrunk its revenue by 27%, to ₹35b. To be frank that doesn't bode well.

Caveat Emptor

Not only did Prime Focus's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). To be specific the EBIT loss came in at ₹614m. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it had negative free cash flow of ₹5.6b over the last twelve months. That means it's on the risky side of things. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Prime Focus you should be aware of.

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. 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.