Stock Analysis

PETRONAS Dagangan Berhad (KLSE:PETDAG) Could Easily Take On More Debt

KLSE:PETDAG
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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 note that PETRONAS Dagangan Berhad (KLSE:PETDAG) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for PETRONAS Dagangan Berhad

What Is PETRONAS Dagangan Berhad's Debt?

As you can see below, PETRONAS Dagangan Berhad had RM20.8m of debt at March 2021, down from RM24.9m a year prior. However, its balance sheet shows it holds RM3.02b in cash, so it actually has RM3.00b net cash.

debt-equity-history-analysis
KLSE:PETDAG Debt to Equity History August 7th 2021

How Strong Is PETRONAS Dagangan Berhad's Balance Sheet?

The latest balance sheet data shows that PETRONAS Dagangan Berhad had liabilities of RM3.03b due within a year, and liabilities of RM219.2m falling due after that. On the other hand, it had cash of RM3.02b and RM1.47b worth of receivables due within a year. So it actually has RM1.23b 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. Succinctly put, PETRONAS Dagangan Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

But the other side of the story is that PETRONAS Dagangan Berhad saw its EBIT decline by 5.4% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine PETRONAS Dagangan Berhad's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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 recorded free cash flow worth a fulsome 83% 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 we empathize with investors who find debt concerning, you should keep in mind that PETRONAS Dagangan Berhad has net cash of RM3.00b, as well as more liquid assets than liabilities. The cherry on top was that in converted 83% of that EBIT to free cash flow, bringing in RM1.1b. So we don't think PETRONAS Dagangan Berhad's use of debt is risky. 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. To that end, you should be aware of the 1 warning sign we've spotted with PETRONAS Dagangan Berhad .

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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