Does Petra Energy Berhad (KLSE:PENERGY) Have A Healthy Balance Sheet?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We note that Petra Energy Berhad (KLSE:PENERGY) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Petra Energy Berhad

What Is Petra Energy Berhad's Net Debt?

As you can see below, at the end of June 2021, Petra Energy Berhad had RM23.6m of debt, up from RM18.5m a year ago. Click the image for more detail. However, it does have RM167.1m in cash offsetting this, leading to net cash of RM143.4m.

A Look At Petra Energy Berhad's Liabilities

According to the last reported balance sheet, Petra Energy Berhad had liabilities of RM210.3m due within 12 months, and liabilities of RM1.30m due beyond 12 months. Offsetting these obligations, it had cash of RM167.1m as well as receivables valued at RM149.5m due within 12 months. So it can boast RM104.9m more liquid assets than total liabilities.

This surplus liquidity suggests that Petra Energy Berhad's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is as strong as an ox. Simply put, the fact that Petra Energy Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Petra Energy Berhad grew its EBIT by 1,014% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Petra Energy Berhad's earnings that will influence how the balance sheet holds up in the future. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Petra Energy 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. Over the last three years, Petra Energy Berhad actually produced more free cash flow than EBIT. 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 we empathize with investors who find debt concerning, you should keep in mind that Petra Energy Berhad has net cash of RM143.4m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of RM55m, being 365% of its EBIT. At the end of the day we're not concerned about Petra Energy Berhad's debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 2 warning signs for Petra Energy Berhad you should be aware of.

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.

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.

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