Is Perdana Petroleum Berhad (KLSE:PERDANA) Using Too Much Debt?

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. Importantly, Perdana Petroleum Berhad (KLSE:PERDANA) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. 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. The first step when considering a company's debt levels is to consider its 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 at March 2021 Perdana Petroleum Berhad had debt of RM233.8m, up from RM125.0m in one year. On the flip side, it has RM34.5m in cash leading to net debt of about RM199.2m.

How Strong Is Perdana Petroleum Berhad's Balance Sheet?

We can see from the most recent balance sheet that Perdana Petroleum Berhad had liabilities of RM154.1m falling due within a year, and liabilities of RM161.4m due beyond that. Offsetting these obligations, it had cash of RM34.5m as well as receivables valued at RM38.6m due within 12 months. So its liabilities total RM242.5m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of RM321.3m, so it does suggest shareholders should keep an eye on Perdana Petroleum Berhad's use of debt. 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 40%, to RM166m. That makes us nervous, to say the least.

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. To be specific the EBIT loss came in at RM28m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. We would feel better if it turned its trailing twelve month loss of RM79m into a profit. So in short it's a really risky stock. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Perdana Petroleum Berhad is showing 1 warning sign in our investment analysis , you should know about...

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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