Here's Why Carimin Petroleum Berhad (KLSE:CARIMIN) Can Manage Its Debt Responsibly

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. As with many other companies Carimin Petroleum Berhad (KLSE:CARIMIN) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Carimin Petroleum Berhad

What Is Carimin Petroleum Berhad's Debt?

You can click the graphic below for the historical numbers, but it shows that Carimin Petroleum Berhad had RM41.0m of debt in September 2020, down from RM47.7m, one year before. However, it does have RM102.9m in cash offsetting this, leading to net cash of RM61.9m.

How Strong Is Carimin Petroleum Berhad's Balance Sheet?

The latest balance sheet data shows that Carimin Petroleum Berhad had liabilities of RM124.8m due within a year, and liabilities of RM29.6m falling due after that. Offsetting these obligations, it had cash of RM102.9m as well as receivables valued at RM83.3m due within 12 months. So it can boast RM31.8m more liquid assets than total liabilities.

It's good to see that Carimin Petroleum Berhad has plenty of liquidity on its balance sheet, suggesting conservative management of liabilities. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, Carimin Petroleum Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Carimin Petroleum Berhad's load is not too heavy, because its EBIT was down 51% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But it is Carimin 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. While Carimin Petroleum Berhad 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. Happily for any shareholders, Carimin Petroleum Berhad actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While it is always sensible to investigate a company's debt, in this case Carimin Petroleum Berhad has RM61.9m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 153% of that EBIT to free cash flow, bringing in -RM15m. So is Carimin Petroleum Berhad'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. However, not all investment risk resides within the balance sheet - far from it. Be aware that Carimin Petroleum Berhad is showing 5 warning signs in our investment analysis , and 1 of those shouldn't be ignored...

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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