Petron Malaysia Refining & Marketing Bhd (KLSE:PETRONM) Has No Shortage Of 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.' 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. Importantly, Petron Malaysia Refining & Marketing Bhd (KLSE:PETRONM) does carry debt. But should shareholders be worried about its use of debt?

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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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

What Is Petron Malaysia Refining & Marketing Bhd's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2024 Petron Malaysia Refining & Marketing Bhd had debt of RM1.18b, up from RM950.0m in one year. However, it also had RM175.3m in cash, and so its net debt is RM999.9m.

How Healthy Is Petron Malaysia Refining & Marketing Bhd's Balance Sheet?

According to the last reported balance sheet, Petron Malaysia Refining & Marketing Bhd had liabilities of RM1.99b due within 12 months, and liabilities of RM295.2m due beyond 12 months. Offsetting these obligations, it had cash of RM175.3m as well as receivables valued at RM1.02b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM1.10b.

Given this deficit is actually higher than the company's market capitalization of RM799.2m, we think shareholders really should watch Petron Malaysia Refining & Marketing Bhd's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

View our latest analysis for Petron Malaysia Refining & Marketing Bhd

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 1.8 times and a disturbingly high net debt to EBITDA ratio of 5.5 hit our confidence in Petron Malaysia Refining & Marketing Bhd like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. Even worse, Petron Malaysia Refining & Marketing Bhd saw its EBIT tank 83% over the last 12 months. If earnings keep going like that over the long term, it has a snowball's chance in hell of paying off that debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Petron Malaysia Refining & Marketing Bhd 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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Petron Malaysia Refining & Marketing Bhd reported free cash flow worth 2.2% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

To be frank both Petron Malaysia Refining & Marketing Bhd's net debt to EBITDA and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. And even its level of total liabilities fails to inspire much confidence. We think the chances that Petron Malaysia Refining & Marketing Bhd has too much debt a very significant. To us, that makes the stock rather risky, like walking through a dog park with your eyes closed. But some investors may feel differently. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example Petron Malaysia Refining & Marketing Bhd has 3 warning signs (and 2 which are a bit unpleasant) we think 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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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.