Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Prinx Chengshan (Cayman) Holding Limited (HKG:1809) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 examine debt levels, we first consider both cash and debt levels, together.
What Is Prinx Chengshan (Cayman) Holding's Debt?
As you can see below, at the end of June 2019, Prinx Chengshan (Cayman) Holding had CN¥354.3m of debt, up from CN¥309.0m a year ago. Click the image for more detail. However, it does have CN¥1.28b in cash offsetting this, leading to net cash of CN¥928.5m.
A Look At Prinx Chengshan (Cayman) Holding's Liabilities
We can see from the most recent balance sheet that Prinx Chengshan (Cayman) Holding had liabilities of CN¥2.19b falling due within a year, and liabilities of CN¥75.4m due beyond that. Offsetting this, it had CN¥1.28b in cash and CN¥1.35b in receivables that were due within 12 months. So it can boast CN¥366.7m more liquid assets than total liabilities.
This short term liquidity is a sign that Prinx Chengshan (Cayman) Holding could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Prinx Chengshan (Cayman) Holding has more cash than debt is arguably a good indication that it can manage its debt safely.
Also good is that Prinx Chengshan (Cayman) Holding grew its EBIT at 17% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Prinx Chengshan (Cayman) Holding's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Prinx Chengshan (Cayman) Holding 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. In the last three years, Prinx Chengshan (Cayman) Holding's free cash flow amounted to 25% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
While we empathize with investors who find debt concerning, you should keep in mind that Prinx Chengshan (Cayman) Holding has net cash of CN¥928m, as well as more liquid assets than liabilities. And we liked the look of last year's 17% year-on-year EBIT growth. So we don't think Prinx Chengshan (Cayman) Holding's use of debt is risky. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Prinx Chengshan (Cayman) Holding insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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