Here's Why Perdana Petroleum Berhad (KLSE:PERDANA) Can Afford Some 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.' 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. Importantly, Perdana Petroleum Berhad (KLSE:PERDANA) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Perdana Petroleum Berhad

What Is Perdana Petroleum Berhad's Net Debt?

The image below, which you can click on for greater detail, shows that Perdana Petroleum Berhad had debt of RM68.8m at the end of December 2021, a reduction from RM270.0m over a year. However, it does have RM23.5m in cash offsetting this, leading to net debt of about RM45.3m.

How Strong Is Perdana Petroleum Berhad's Balance Sheet?

According to the last reported balance sheet, Perdana Petroleum Berhad had liabilities of RM141.6m due within 12 months, and liabilities of RM168.7m due beyond 12 months. Offsetting these obligations, it had cash of RM23.5m as well as receivables valued at RM74.6m due within 12 months. So it has liabilities totalling RM212.2m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of RM266.0m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. There's no doubt that we learn most about debt from the balance sheet. But it is Perdana 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.

In the last year Perdana Petroleum Berhad had a loss before interest and tax, and actually shrunk its revenue by 23%, to RM161m. To be frank that doesn't bode well.

Caveat Emptor

While Perdana Petroleum Berhad's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Its EBIT loss was a whopping RM93m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of RM325m. In the meantime, we consider the stock very risky. 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. For example, we've discovered 2 warning signs for Perdana Petroleum Berhad (1 is a bit concerning!) that you should be aware of before investing here.

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. 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.