Is Panama Petrochem (NSE:PANAMAPET) A Risky Investment?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that Panama Petrochem Limited (NSE:PANAMAPET) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Panama Petrochem

What Is Panama Petrochem's Debt?

As you can see below, Panama Petrochem had ₹298.1m of debt at March 2022, down from ₹656.4m a year prior. But it also has ₹1.39b in cash to offset that, meaning it has ₹1.10b net cash.

A Look At Panama Petrochem's Liabilities

Zooming in on the latest balance sheet data, we can see that Panama Petrochem had liabilities of ₹4.76b due within 12 months and liabilities of ₹92.0m due beyond that. Offsetting this, it had ₹1.39b in cash and ₹3.18b in receivables that were due within 12 months. So it has liabilities totalling ₹273.7m more than its cash and near-term receivables, combined.

Having regard to Panama Petrochem's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the ₹18.6b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Panama Petrochem boasts net cash, so it's fair to say it does not have a heavy debt load!

Another good sign is that Panama Petrochem has been able to increase its EBIT by 21% in twelve months, making it easier to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Panama Petrochem will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Panama Petrochem 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, Panama Petrochem produced sturdy free cash flow equating to 51% 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

While it is always sensible to look at a company's total liabilities, it is very reassuring that Panama Petrochem has ₹1.10b in net cash. And we liked the look of last year's 21% year-on-year EBIT growth. So is Panama Petrochem's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Panama Petrochem .

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.