Is PetroChina (HKG:857) A Risky Investment?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies PetroChina Company Limited (HKG:857) makes use of debt. But is this debt a concern to shareholders?

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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for PetroChina

What Is PetroChina's Net Debt?

The image below, which you can click on for greater detail, shows that PetroChina had debt of CN¥216.4b at the end of September 2024, a reduction from CN¥297.9b over a year. But it also has CN¥276.0b in cash to offset that, meaning it has CN¥59.6b net cash.

How Healthy Is PetroChina's Balance Sheet?

The latest balance sheet data shows that PetroChina had liabilities of CN¥715.3b due within a year, and liabilities of CN¥382.6b falling due after that. On the other hand, it had cash of CN¥276.0b and CN¥94.6b worth of receivables due within a year. So its liabilities total CN¥727.3b more than the combination of its cash and short-term receivables.

PetroChina has a very large market capitalization of CN¥1.39t, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, PetroChina also has more cash than debt, so we're pretty confident it can manage its debt safely.

But the other side of the story is that PetroChina saw its EBIT decline by 2.2% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if PetroChina 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. PetroChina 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. During the last three years, PetroChina produced sturdy free cash flow equating to 68% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

Although PetroChina's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥59.6b. And it impressed us with free cash flow of CN¥157b, being 68% of its EBIT. So we are not troubled with PetroChina's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for PetroChina (1 doesn't sit too well with us) you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.