We Think PCCS Group Berhad (KLSE:PCCS) Is Taking Some Risk With Its Debt

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 PCCS Group Berhad (KLSE:PCCS) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for PCCS Group Berhad

How Much Debt Does PCCS Group Berhad Carry?

The image below, which you can click on for greater detail, shows that PCCS Group Berhad had debt of RM51.2m at the end of September 2020, a reduction from RM63.9m over a year. But on the other hand it also has RM65.2m in cash, leading to a RM14.0m net cash position.

How Healthy Is PCCS Group Berhad's Balance Sheet?

According to the last reported balance sheet, PCCS Group Berhad had liabilities of RM102.7m due within 12 months, and liabilities of RM26.4m due beyond 12 months. On the other hand, it had cash of RM65.2m and RM51.2m worth of receivables due within a year. So its liabilities total RM12.7m more than the combination of its cash and short-term receivables.

Given PCCS Group Berhad has a market capitalization of RM96.3m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, PCCS Group Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

Importantly, PCCS Group Berhad's EBIT fell a jaw-dropping 64% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But it is PCCS Group Berhad'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. PCCS Group Berhad 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. During the last three years, PCCS Group Berhad produced sturdy free cash flow equating to 51% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

Although PCCS Group Berhad's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of RM14.0m. So although we see some areas for improvement, we're not too worried about PCCS Group Berhad's balance sheet. 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. Be aware that PCCS Group Berhad is showing 2 warning signs in our investment analysis , you should know about...

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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