Is Persta Resources (HKG:3395) Using Debt In A Risky Way?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Persta Resources Inc. (HKG:3395) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Persta Resources

What Is Persta Resources's Net Debt?

As you can see below, at the end of September 2020, Persta Resources had CA$25.4m of debt, up from CA$21.3m a year ago. Click the image for more detail. However, it also had CA$662.9k in cash, and so its net debt is CA$24.7m.

How Healthy Is Persta Resources's Balance Sheet?

According to the last reported balance sheet, Persta Resources had liabilities of CA$9.04m due within 12 months, and liabilities of CA$30.0m due beyond 12 months. Offsetting this, it had CA$662.9k in cash and CA$2.81m in receivables that were due within 12 months. So it has liabilities totalling CA$35.5m more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the CA$16.2m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Persta Resources would probably need a major re-capitalization if its creditors were to demand repayment. There's no doubt that we learn most about debt from the balance sheet. But it is Persta Resources's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Persta Resources reported revenue of CA$13m, which is a gain of 8.4%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Importantly, Persta Resources had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable CA$30m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it burned through CA$4.5m in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Persta Resources (at least 2 which are potentially serious) , and understanding them should be part of your investment process.

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.

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