Here's Why Petronet LNG (NSE:PETRONET) Can Manage Its Debt Responsibly

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. Importantly, Petronet LNG Limited (NSE:PETRONET) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Petronet LNG

What Is Petronet LNG's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Petronet LNG had ₹31.9b of debt in September 2023, down from ₹34.7b, one year before. But it also has ₹78.4b in cash to offset that, meaning it has ₹46.5b net cash.

How Strong Is Petronet LNG's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Petronet LNG had liabilities of ₹34.7b due within 12 months and liabilities of ₹44.0b due beyond that. On the other hand, it had cash of ₹78.4b and ₹35.5b worth of receivables due within a year. So it actually has ₹35.2b more liquid assets than total liabilities.

This short term liquidity is a sign that Petronet LNG could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Petronet LNG boasts net cash, so it's fair to say it does not have a heavy debt load!

Fortunately, Petronet LNG grew its EBIT by 2.7% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Petronet LNG's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Petronet LNG has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Petronet LNG recorded free cash flow worth 61% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Petronet LNG has net cash of ₹46.5b, as well as more liquid assets than liabilities. So is Petronet LNG's debt a risk? It doesn't seem so to us. 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 1 warning sign for Petronet LNG that 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.