Is Persta Resources (HKG:3395) Using Debt 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.' 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 note that Persta Resources Inc. (HKG:3395) does have debt on its balance sheet. But is this debt a concern to shareholders?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Persta Resources

What Is Persta Resources's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2021 Persta Resources had CA$26.0m of debt, an increase on CA$22.9m, over one year. However, because it has a cash reserve of CA$1.19m, its net debt is less, at about CA$24.8m.

How Strong Is Persta Resources' Balance Sheet?

According to the last reported balance sheet, Persta Resources had liabilities of CA$34.8m due within 12 months, and liabilities of CA$6.23m due beyond 12 months. Offsetting this, it had CA$1.19m in cash and CA$1.65m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$38.2m.

When you consider that this deficiency exceeds the company's CA$27.6m market capitalization, you might well be inclined to review the balance sheet intently. 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. When analysing debt levels, the balance sheet is the obvious place to start. 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$14m, which is a gain of 44%, 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

Even though Persta Resources managed to grow its top line quite deftly, the cold hard truth is that it is losing money on the EBIT line. Its EBIT loss was a whopping CA$11m. Considering that alongside the liabilities mentioned above make us nervous 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$4.2m in negative free cash flow over the last year. That means it's on the risky side of things. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example Persta Resources has 4 warning signs (and 2 which shouldn't be ignored) we think you should know about.

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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