We Think PETRONAS Dagangan Berhad (KLSE:PETDAG) Can Manage Its Debt With Ease

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.' 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. We can see that PETRONAS Dagangan Berhad (KLSE:PETDAG) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for PETRONAS Dagangan Berhad

What Is PETRONAS Dagangan Berhad's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2021 PETRONAS Dagangan Berhad had RM16.0m of debt, an increase on RM14.9m, over one year. But it also has RM2.83b in cash to offset that, meaning it has RM2.81b net cash.

How Strong 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 RM3.07b due within 12 months and liabilities of RM220.9m due beyond that. Offsetting these obligations, it had cash of RM2.83b as well as receivables valued at RM1.82b due within 12 months. So it can boast RM1.35b more liquid assets than total liabilities.

This surplus suggests that PETRONAS Dagangan Berhad has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, PETRONAS Dagangan Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that PETRONAS Dagangan Berhad has boosted its EBIT by 39%, thus reducing the spectre of future debt repayments. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 87% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case PETRONAS Dagangan Berhad has RM2.81b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of RM761m, being 87% of its EBIT. 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. For example - PETRONAS Dagangan Berhad has 1 warning sign we think you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.