These 4 Measures Indicate That PGF Capital Berhad (KLSE:PGF) Is Using Debt Extensively

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. We can see that PGF Capital Berhad (KLSE:PGF) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for PGF Capital Berhad

What Is PGF Capital Berhad's Debt?

The image below, which you can click on for greater detail, shows that at May 2022 PGF Capital Berhad had debt of RM25.9m, up from RM23.1m in one year. However, it also had RM8.55m in cash, and so its net debt is RM17.3m.

How Healthy Is PGF Capital Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that PGF Capital Berhad had liabilities of RM22.2m due within 12 months and liabilities of RM48.2m due beyond that. Offsetting these obligations, it had cash of RM8.55m as well as receivables valued at RM27.8m due within 12 months. So it has liabilities totalling RM34.0m more than its cash and near-term receivables, combined.

Given PGF Capital Berhad has a market capitalization of RM186.0m, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

PGF Capital Berhad's net debt is only 1.2 times its EBITDA. And its EBIT easily covers its interest expense, being 11.7 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The modesty of its debt load may become crucial for PGF Capital Berhad if management cannot prevent a repeat of the 49% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since PGF Capital Berhad will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, PGF Capital Berhad reported free cash flow worth 3.6% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

PGF Capital Berhad's EBIT growth rate was a real negative on this analysis, although the other factors we considered cast it in a significantly better light. In particular, its interest cover was re-invigorating. Taking the abovementioned factors together we do think PGF Capital Berhad's debt poses some risks to the business. So while that leverage does boost returns on equity, we wouldn't really want to see it increase from here. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with PGF Capital Berhad (at least 1 which makes us a bit uncomfortable) , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.