We Think Petron Malaysia Refining & Marketing Bhd (KLSE:PETRONM) Is Taking Some Risk With Its Debt

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.' 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 note that Petron Malaysia Refining & Marketing Bhd (KLSE:PETRONM) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Petron Malaysia Refining & Marketing Bhd

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

You can click the graphic below for the historical numbers, but it shows that as of March 2022 Petron Malaysia Refining & Marketing Bhd had RM931.8m of debt, an increase on RM490.0m, over one year. However, it also had RM167.3m in cash, and so its net debt is RM764.5m.

A Look At Petron Malaysia Refining & Marketing Bhd's Liabilities

We can see from the most recent balance sheet that Petron Malaysia Refining & Marketing Bhd had liabilities of RM2.60b falling due within a year, and liabilities of RM201.8m due beyond that. Offsetting these obligations, it had cash of RM167.3m as well as receivables valued at RM1.35b due within 12 months. So its liabilities total RM1.28b more than the combination of its cash and short-term receivables.

This is a mountain of leverage relative to its market capitalization of RM1.46b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

We'd say that Petron Malaysia Refining & Marketing Bhd's moderate net debt to EBITDA ratio ( being 1.5), indicates prudence when it comes to debt. And its commanding EBIT of 24.7 times its interest expense, implies the debt load is as light as a peacock feather. On top of that, Petron Malaysia Refining & Marketing Bhd grew its EBIT by 76% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Petron Malaysia Refining & Marketing Bhd's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Petron Malaysia Refining & Marketing Bhd burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

We feel some trepidation about Petron Malaysia Refining & Marketing Bhd's difficulty conversion of EBIT to free cash flow, but we've got positives to focus on, too. To wit both its interest cover and EBIT growth rate were encouraging signs. Looking at all the angles mentioned above, it does seem to us that Petron Malaysia Refining & Marketing Bhd is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Petron Malaysia Refining & Marketing Bhd is showing 4 warning signs in our investment analysis , and 2 of those don't sit too well with us...

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.