Is Perdana Petroleum Berhad (KLSE:PERDANA) Using Too Much 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 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 can see that Perdana Petroleum Berhad (KLSE:PERDANA) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.

View our latest analysis for Perdana Petroleum Berhad

How Much Debt Does Perdana Petroleum Berhad Carry?

The image below, which you can click on for greater detail, shows that Perdana Petroleum Berhad had debt of RM36.7m at the end of June 2023, a reduction from RM60.9m over a year. But on the other hand it also has RM39.9m in cash, leading to a RM3.20m net cash position.

A Look At Perdana Petroleum Berhad's Liabilities

The latest balance sheet data shows that Perdana Petroleum Berhad had liabilities of RM90.0m due within a year, and liabilities of RM137.6m falling due after that. Offsetting this, it had RM39.9m in cash and RM103.6m in receivables that were due within 12 months. So its liabilities total RM84.0m more than the combination of its cash and short-term receivables.

Of course, Perdana Petroleum Berhad has a market capitalization of RM577.2m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Perdana Petroleum Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

It was also good to see that despite losing money on the EBIT line last year, Perdana Petroleum Berhad turned things around in the last 12 months, delivering and EBIT of RM47m. The balance sheet is clearly the area to focus on when you are analysing debt. 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Perdana Petroleum 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 year, Perdana Petroleum Berhad recorded free cash flow worth a fulsome 93% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing Up

While Perdana Petroleum Berhad does have more liabilities than liquid assets, it also has net cash of RM3.20m. And it impressed us with free cash flow of RM44m, being 93% of its EBIT. So we don't have any problem with Perdana Petroleum Berhad's use of debt. 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 1 warning sign for Perdana Petroleum Berhad that you should be aware of before investing here.

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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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.