Is Petra Energy Berhad (KLSE:PENERGY) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. As with many other companies Petra Energy Berhad (KLSE:PENERGY) makes use of debt. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. 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 Petra Energy Berhad

How Much Debt Does Petra Energy Berhad Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Petra Energy Berhad had RM31.9m of debt, an increase on RM26.8m, over one year. However, its balance sheet shows it holds RM154.5m in cash, so it actually has RM122.7m net cash.

How Healthy Is Petra Energy Berhad's Balance Sheet?

According to the last reported balance sheet, Petra Energy Berhad had liabilities of RM232.9m due within 12 months, and liabilities of RM5.72m due beyond 12 months. Offsetting this, it had RM154.5m in cash and RM228.3m in receivables that were due within 12 months. So it can boast RM144.1m more liquid assets than total liabilities.

This surplus strongly suggests that Petra Energy Berhad has a rock-solid balance sheet (and the debt is of no concern whatsoever). On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Petra Energy Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

Better yet, Petra Energy Berhad grew its EBIT by 102% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Petra Energy 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Petra Energy 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, Petra Energy Berhad actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Petra Energy Berhad has net cash of RM122.7m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of RM81m, being 134% of its EBIT. At the end of the day we're not concerned about Petra Energy Berhad's debt. 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. For example, we've discovered 2 warning signs for Petra Energy Berhad that you should be aware of before investing here.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.