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 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 can see that PDD Holdings Inc. (NASDAQ:PDD) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
Check out our latest analysis for PDD Holdings
What Is PDD Holdings’s Debt?
As you can see below, PDD Holdings had CN¥5.31b of debt at March 2024, down from CN¥15.3ba year prior. However, its balance sheet shows it holds CN¥242.1b in cash, so it actually has CN¥236.8b net cash.
A Look At PDD Holdings’ Liabilities
According to the last reported balance sheet, PDD Holdings had liabilities of CN¥151.4b due within 12 months, and liabilities of CN¥7.72b due beyond 12 months. Offsetting these obligations, it had cash of CN¥242.1b as well as receivables valued at CN¥11.7b due within 12 months. So it can boast CN¥94.8b more liquid assets than total liabilities.
This surplus suggests that PDD Holdings has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that PDD Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.
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Better yet, PDD Holdings grew its EBIT by 121% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analyzing debt. But ultimately the future profitability of the business will decide if PDD Holdings can strengthen its balance sheet over time. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. PDD Holdings 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. Happily for any shareholders, PDD Holdings actually produced more free cash flow than EBIT over the last three years. There’s nothing better than incoming cash when it comes to staying in your lenders’ good graces.
Summing Up
While we empathize with investors who find debt concerning, you should keep in mind that PDD Holdings has net cash of CN¥236.8b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of CN¥113b, being 152% of its EBIT. So we don’t think PDD Holdings’s use of debt is risky. The balance sheet is clearly the area to focus on when you are analyzing debt. However, not all investment risk resides within the balance sheet – far from it. For example, we’ve discovered 1 warning sign for PDD Holdings that you should be aware of before investing here.
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.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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