Here’s why Praemium (ASX:PPS) has significant leverage

Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We note that Praemium Limited (ASX:PPS) has debt on its balance sheet. But does this debt worry shareholders?

Why is debt risky?

Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.

See our latest analysis for Praemium

What is Praemium Debt?

The image below, which you can click on for more details, shows that Praemium had A$12.1 million in debt at the end of December 2021, a reduction from A$15.1 million on a year. But on the other hand, he also has A$19.4 million in cash, resulting in a net cash position of A$7.28 million.

ASX: Historical Debt to Equity PPS May 30, 2022

How strong is Praemium’s balance sheet?

The latest balance sheet data shows that Praemium had liabilities of A$21.9 million due within one year, and liabilities of A$9.67 million falling due thereafter. In return, he had A$19.4 million in cash and A$9.78 million in debt due within 12 months. Thus, its liabilities outweigh the sum of its cash and (current) receivables of A$2.37 million.

This state of affairs indicates that Praemium’s balance sheet looks quite strong, as its total liabilities roughly equal its liquid assets. The A$337.7 million company is therefore highly unlikely to run out of cash, but it’s still worth keeping an eye on the balance sheet. Despite its notable liabilities, Praemium has a net cash position, so it’s fair to say that it doesn’t have a lot of debt!

Shareholders should know that Praemium’s EBIT fell by 87% last year. If this earnings trend continues, paying off debt will be about as easy as herding cats on a roller coaster. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Praemium can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.

Finally, a business needs free cash flow to pay off its debts; book profits are not enough. Although Praemium has net cash on its balance sheet, it’s still worth looking at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how fast it’s building (or erodes) this cash balance. . Over the past three years, Praemium’s free cash flow has been 29% of its EBIT, less than we expected. It’s not great when it comes to paying off debt.

Summary

We could understand if investors are worried about Praemium’s liabilities, but we can take comfort in the fact that it has a net cash position of A$7.28 million. So, while Praemium doesn’t have a great track record, it’s certainly not that bad. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. For example – Praemium a 1 warning sign we think you should know.

If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-neutral growth stocks right away.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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