Here's Why Perma-Pipe International Holdings (NASDAQ:PPIH) Can Afford Some Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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 note that Perma-Pipe International Holdings, Inc. (NASDAQ:PPIH) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Perma-Pipe International Holdings

What Is Perma-Pipe International Holdings's Debt?

The image below, which you can click on for greater detail, shows that Perma-Pipe International Holdings had debt of US$12.3m at the end of January 2021, a reduction from US$15.7m over a year. However, because it has a cash reserve of US$7.17m, its net debt is less, at about US$5.16m.

How Healthy Is Perma-Pipe International Holdings' Balance Sheet?

We can see from the most recent balance sheet that Perma-Pipe International Holdings had liabilities of US$28.3m falling due within a year, and liabilities of US$25.1m due beyond that. Offsetting these obligations, it had cash of US$7.17m as well as receivables valued at US$29.4m due within 12 months. So it has liabilities totalling US$16.8m more than its cash and near-term receivables, combined.

Perma-Pipe International Holdings has a market capitalization of US$51.0m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. There's no doubt that we learn most about debt from the balance sheet. But it is Perma-Pipe International Holdings'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.

Over 12 months, Perma-Pipe International Holdings made a loss at the EBIT level, and saw its revenue drop to US$85m, which is a fall of 34%. To be frank that doesn't bode well.

Caveat Emptor

Not only did Perma-Pipe International Holdings's revenue slip over the last twelve months, but it also produced negative earnings before interest and tax (EBIT). Its EBIT loss was a whopping US$11m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled US$1.8m in negative free cash flow over the last twelve months. So suffice it to say we do consider the stock to be risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Perma-Pipe International Holdings that you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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