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.' 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. Importantly, Petronet LNG Limited (NSE:PETRONET) does carry debt. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for Petronet LNG
What Is Petronet LNG's Debt?
As you can see below, Petronet LNG had ₹230.0m of debt at March 2022, down from ₹644.0m a year prior. But it also has ₹52.0b in cash to offset that, meaning it has ₹51.8b net cash.
How Strong Is Petronet LNG's Balance Sheet?
We can see from the most recent balance sheet that Petronet LNG had liabilities of ₹27.4b falling due within a year, and liabilities of ₹49.6b due beyond that. Offsetting this, it had ₹52.0b in cash and ₹26.8b in receivables that were due within 12 months. So it can boast ₹1.93b more liquid assets than total liabilities.
This state of affairs indicates that Petronet LNG's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the ₹327.4b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Petronet LNG has more cash than debt is arguably a good indication that it can manage its debt safely.
Also good is that Petronet LNG grew its EBIT at 14% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Petronet LNG 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, Petronet LNG generated free cash flow amounting to a very robust 82% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
Summing up
While we empathize with investors who find debt concerning, you should keep in mind that Petronet LNG has net cash of ₹51.8b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of ₹34b, being 82% of its EBIT. So is Petronet LNG's debt a risk? It doesn't seem so to us. 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. Case in point: We've spotted 1 warning sign for Petronet LNG you should be aware of.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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.
About NSEI:PETRONET
Petronet LNG
Engages in the import, storage, regasification, and supply of liquefied natural gas (LNG) in India.
Solid track record with excellent balance sheet and pays a dividend.