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Is PSP Projects (NSE:PSPPROJECT) A Risky Investment?

Simply Wall St

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.' 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. Importantly, PSP Projects Limited (NSE:PSPPROJECT) does carry debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for PSP Projects

What Is PSP Projects's Net Debt?

As you can see below, PSP Projects had ₹297.9m of debt, at March 2019, which is about the same the year before. You can click the chart for greater detail. But on the other hand it also has ₹2.78b in cash, leading to a ₹2.48b net cash position.

NSEI:PSPPROJECT Historical Debt, July 29th 2019

A Look At PSP Projects's Liabilities

Zooming in on the latest balance sheet data, we can see that PSP Projects had liabilities of ₹3.64b due within 12 months and liabilities of ₹4.09m due beyond that. Offsetting these obligations, it had cash of ₹2.78b as well as receivables valued at ₹1.60b due within 12 months. So it can boast ₹729.0m more liquid assets than total liabilities.

This surplus suggests that PSP Projects has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, PSP Projects boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that PSP Projects has boosted its EBIT by 32%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine PSP Projects'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. PSP Projects 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. Over the last three years, PSP Projects recorded negative free cash flow, in total. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that PSP Projects has net cash of ₹2.5b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 32% over the last year. So we don't have any problem with PSP Projects's use of debt. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that PSP Projects insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.