Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 PBsystems,Inc. (FKSE:4447) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
Check out our latest analysis for PBsystemsInc
What Is PBsystemsInc's Net Debt?
You can click the graphic below for the historical numbers, but it shows that PBsystemsInc had JP¥229.0m of debt in September 2020, down from JP¥250.0m, one year before. However, it does have JP¥656.0m in cash offsetting this, leading to net cash of JP¥427.0m.
A Look At PBsystemsInc's Liabilities
The latest balance sheet data shows that PBsystemsInc had liabilities of JP¥327.0m due within a year, and liabilities of JP¥180.0m falling due after that. Offsetting these obligations, it had cash of JP¥656.0m as well as receivables valued at JP¥371.0m due within 12 months. So it actually has JP¥520.0m more liquid assets than total liabilities.
This surplus suggests that PBsystemsInc has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that PBsystemsInc has more cash than debt is arguably a good indication that it can manage its debt safely.
On top of that, PBsystemsInc grew its EBIT by 43% over the last twelve months, and that growth will make it easier to handle its debt. There's no doubt that we learn most about debt from the balance sheet. But it is PBsystemsInc'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. PBsystemsInc 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. In the last three years, PBsystemsInc's free cash flow amounted to 38% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
Summing up
While we empathize with investors who find debt concerning, you should keep in mind that PBsystemsInc has net cash of JP¥427.0m, as well as more liquid assets than liabilities. And we liked the look of last year's 43% year-on-year EBIT growth. So we don't think PBsystemsInc's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 4 warning signs for PBsystemsInc you should be aware of, and 1 of them shouldn't be ignored.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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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About TSE:4447
PBsystemsInc
Engages in the construction of secure cloud system in Japan.
Flawless balance sheet with proven track record.
