PDD Holdings (NASDAQ:PDD) Seems To Use Debt Rather Sparingly

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that PDD Holdings Inc. (NASDAQ:PDD) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for PDD Holdings

How Much Debt Does PDD Holdings Carry?

The image below, which you can click on for greater detail, shows that at December 2022 PDD Holdings had debt of CN¥15.5b, up from CN¥11.8b in one year. But it also has CN¥149.4b in cash to offset that, meaning it has CN¥134.0b net cash.

How Strong Is PDD Holdings' Balance Sheet?

The latest balance sheet data shows that PDD Holdings had liabilities of CN¥116.9b due within a year, and liabilities of CN¥2.46b falling due after that. Offsetting these obligations, it had cash of CN¥149.4b as well as receivables valued at CN¥7.35b due within 12 months. So it actually has CN¥37.4b more liquid assets than total liabilities.

This short term liquidity is a sign that PDD Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that PDD Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.

Even more impressive was the fact that PDD Holdings grew its EBIT by 341% over twelve months. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if PDD Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While PDD Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, PDD Holdings actually produced more free cash flow than EBIT over the last two years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that PDD Holdings has net cash of CN¥134.0b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥48b, being 197% of its EBIT. So we don't think PDD Holdings'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. For example, we've discovered 1 warning sign for PDD Holdings that you should be aware of before investing here.

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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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.