Is Barakah Offshore Petroleum Berhad (KLSE:BARAKAH) Using Too Much Debt?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Barakah Offshore Petroleum Berhad (KLSE:BARAKAH) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. 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.

See our latest analysis for Barakah Offshore Petroleum Berhad

How Much Debt Does Barakah Offshore Petroleum Berhad Carry?

As you can see below, Barakah Offshore Petroleum Berhad had RM51.9m of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. However, it does have RM58.5m in cash offsetting this, leading to net cash of RM6.62m.

How Healthy Is Barakah Offshore Petroleum Berhad's Balance Sheet?

The latest balance sheet data shows that Barakah Offshore Petroleum Berhad had liabilities of RM113.6m due within a year, and liabilities of RM219.0k falling due after that. Offsetting this, it had RM58.5m in cash and RM39.3m in receivables that were due within 12 months. So it has liabilities totalling RM16.0m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Barakah Offshore Petroleum Berhad is worth RM45.1m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Barakah Offshore Petroleum Berhad also has more cash than debt, so we're pretty confident it can manage its debt safely.

Better yet, Barakah Offshore Petroleum Berhad grew its EBIT by 488% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Barakah Offshore Petroleum Berhad's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Barakah Offshore Petroleum Berhad 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. Over the last three years, Barakah Offshore Petroleum Berhad recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

Although Barakah Offshore Petroleum Berhad's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of RM6.62m. And it impressed us with its EBIT growth of 488% over the last year. So we are not troubled with Barakah Offshore Petroleum Berhad'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. To that end, you should learn about the 3 warning signs we've spotted with Barakah Offshore Petroleum Berhad (including 1 which makes us a bit uncomfortable) .

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.