We Think Petra Energy Berhad (KLSE:PENERGY) Can Stay On Top Of Its Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Petra Energy Berhad (KLSE:PENERGY) makes use of debt. But the more important question is: how much risk is that debt creating?

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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Petra Energy Berhad

How Much Debt Does Petra Energy Berhad Carry?

The image below, which you can click on for greater detail, shows that Petra Energy Berhad had debt of RM27.2m at the end of December 2020, a reduction from RM37.3m over a year. But on the other hand it also has RM175.2m in cash, leading to a RM148.0m net cash position.

How Strong Is Petra Energy Berhad's Balance Sheet?

According to the last reported balance sheet, Petra Energy Berhad had liabilities of RM238.7m due within 12 months, and liabilities of RM15.9m due beyond 12 months. Offsetting these obligations, it had cash of RM175.2m as well as receivables valued at RM164.8m due within 12 months. So it can boast RM85.4m more liquid assets than total liabilities.

This surplus suggests that Petra Energy Berhad is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. 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.

The modesty of its debt load may become crucial for Petra Energy Berhad if management cannot prevent a repeat of the 30% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. 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.

Finally, while the tax-man may adore accounting profits, lenders only accept 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. Happily for any shareholders, Petra Energy Berhad actually produced more free cash flow than EBIT over the last two years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to investigate a company's debt, in this case Petra Energy Berhad has RM148.0m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 316% of that EBIT to free cash flow, bringing in RM34m. So is Petra Energy Berhad's debt a risk? It doesn't seem so to us. 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. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Petra Energy Berhad you should know about.

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. 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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