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

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. We can see that Persta Resources Inc. (HKG:3395) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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. 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. 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 Debt?

As you can see below, at the end of June 2021, Persta Resources had CA$26.3m of debt, up from CA$25.1m a year ago. Click the image for more detail. However, because it has a cash reserve of CA$991.7k, its net debt is less, at about CA$25.3m.

A Look At Persta Resources' Liabilities

According to the last reported balance sheet, Persta Resources had liabilities of CA$11.4m due within 12 months, and liabilities of CA$30.3m due beyond 12 months. Offsetting this, it had CA$991.7k in cash and CA$1.80m in receivables that were due within 12 months. So its liabilities total CA$39.0m more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of CA$29.4m, we think shareholders really should watch Persta Resources's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. The balance sheet is clearly the area to focus on when you are analysing debt. 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$16m, which is a gain of 34%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

Despite the top line growth, Persta Resources still had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable CA$12m 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 had negative free cash flow of CA$2.8m over the last twelve months. So suffice it to say we consider the stock to be risky. 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. For example Persta Resources has 5 warning signs (and 2 which don't sit too well with us) we think you should know about.

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.

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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