Precious Dragon Technology Holdings (HKG:1861) Seems To Use Debt Quite Sensibly

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'. 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, Precious Dragon Technology Holdings Limited (HKG:1861) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Precious Dragon Technology Holdings

What Is Precious Dragon Technology Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Precious Dragon Technology Holdings had HK$40.0m of debt in December 2019, down from HK$75.0m, one year before. But on the other hand it also has HK$135.0m in cash, leading to a HK$95.0m net cash position.

How Healthy Is Precious Dragon Technology Holdings's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Precious Dragon Technology Holdings had liabilities of HK$115.8m due within 12 months and liabilities of HK$28.6m due beyond that. Offsetting these obligations, it had cash of HK$135.0m as well as receivables valued at HK$30.3m due within 12 months. So it can boast HK$20.8m more liquid assets than total liabilities.

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

On the other hand, Precious Dragon Technology Holdings's EBIT dived 14%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Precious Dragon Technology 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Precious Dragon Technology 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. In the last three years, Precious Dragon Technology Holdings's free cash flow amounted to 41% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to investigate a company's debt, in this case Precious Dragon Technology Holdings has HK$95.0m in net cash and a decent-looking balance sheet. So we don't have any problem with Precious Dragon Technology Holdings's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should learn about the 4 warning signs we've spotted with Precious Dragon Technology Holdings (including 1 which is is potentially serious) .

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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.

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