Here's Why PETRONAS Dagangan Berhad (KLSE:PETDAG) Can Manage Its Debt Responsibly

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.' 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 PETRONAS Dagangan Berhad (KLSE:PETDAG) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for PETRONAS Dagangan Berhad

What Is PETRONAS Dagangan Berhad's Debt?

The image below, which you can click on for greater detail, shows that at June 2022 PETRONAS Dagangan Berhad had debt of RM700.0m, up from RM16.7m in one year. But on the other hand it also has RM2.65b in cash, leading to a RM1.95b net cash position.

How Healthy Is PETRONAS Dagangan Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that PETRONAS Dagangan Berhad had liabilities of RM11.3b due within 12 months and liabilities of RM280.5m due beyond that. Offsetting this, it had RM2.65b in cash and RM10.3b in receivables that were due within 12 months. So it can boast RM1.38b more liquid assets than total liabilities.

This short term liquidity is a sign that PETRONAS Dagangan Berhad could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that PETRONAS Dagangan Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.

PETRONAS Dagangan Berhad's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if PETRONAS Dagangan Berhad can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. PETRONAS Dagangan 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, PETRONAS Dagangan Berhad reported free cash flow worth 9.8% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Summing Up

While it is always sensible to investigate a company's debt, in this case PETRONAS Dagangan Berhad has RM1.95b in net cash and a decent-looking balance sheet. So we don't have any problem with PETRONAS Dagangan Berhad's use of debt. 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. We've identified 2 warning signs with PETRONAS Dagangan Berhad , and understanding them should be part of your investment process.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.