Pearl River Holdings (CVE:PRH) Has A Rock Solid Balance Sheet

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Pearl River Holdings Limited (CVE:PRH) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Pearl River Holdings

What Is Pearl River Holdings's Debt?

As you can see below, at the end of December 2020, Pearl River Holdings had CN¥10.3m of debt, up from CN¥8.05m a year ago. Click the image for more detail. However, its balance sheet shows it holds CN¥52.0m in cash, so it actually has CN¥41.7m net cash.

How Strong Is Pearl River Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Pearl River Holdings had liabilities of CN¥58.3m due within 12 months and liabilities of CN¥24.9m due beyond that. Offsetting this, it had CN¥52.0m in cash and CN¥72.4m in receivables that were due within 12 months. So it actually has CN¥41.1m more liquid assets than total liabilities.

This excess liquidity is a great indication that Pearl River Holdings' balance sheet is almost as strong as Fort Knox. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Simply put, the fact that Pearl River 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 Pearl River Holdings grew its EBIT by 144% 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 you can't view debt in total isolation; since Pearl River Holdings will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Pearl River 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, Pearl River Holdings actually produced more free cash flow than EBIT over the last three 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, the bottom line is that Pearl River Holdings has net cash of CN¥41.7m and plenty of liquid assets. The cherry on top was that in converted 147% of that EBIT to free cash flow, bringing in CN¥24m. The bottom line is that Pearl River Holdings's use of debt is absolutely fine. 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. Be aware that Pearl River Holdings is showing 2 warning signs in our investment analysis , and 1 of those makes us a bit uncomfortable...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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. 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.

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