Is Prince Housing & Development (TPE:2511) Using Debt Sensibly?

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 Prince Housing & Development Corp. (TPE:2511) does use debt in its business. 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 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Prince Housing & Development

What Is Prince Housing & Development's Debt?

The image below, which you can click on for greater detail, shows that Prince Housing & Development had debt of NT$16.1b at the end of September 2020, a reduction from NT$20.5b over a year. However, it also had NT$6.39b in cash, and so its net debt is NT$9.69b.

A Look At Prince Housing & Development's Liabilities

Zooming in on the latest balance sheet data, we can see that Prince Housing & Development had liabilities of NT$6.61b due within 12 months and liabilities of NT$21.7b due beyond that. Offsetting this, it had NT$6.39b in cash and NT$961.1m in receivables that were due within 12 months. So its liabilities total NT$21.0b more than the combination of its cash and short-term receivables.

When you consider that this deficiency exceeds the company's NT$18.3b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. When analysing debt levels, the balance sheet is the obvious place to start. But it is Prince Housing & Development'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.

Over 12 months, Prince Housing & Development made a loss at the EBIT level, and saw its revenue drop to NT$11b, which is a fall of 22%. That makes us nervous, to say the least.

Caveat Emptor

Not only did Prince Housing & Development's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Indeed, it lost NT$87m at the EBIT level. 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. On the bright side, we note that trailing twelve month EBIT is worse than the free cash flow of NT$4.4b and the profit of NT$473m. So one might argue that there's still a chance it can get things on the right track. 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 Prince Housing & Development is showing 5 warning signs in our investment analysis , and 1 of those is potentially serious...

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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