Is Reach Energy Berhad (KLSE:REACH) A Risky Investment?

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.' 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. Importantly, Reach Energy Berhad (KLSE:REACH) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

See our latest analysis for Reach Energy Berhad

How Much Debt Does Reach Energy Berhad Carry?

The image below, which you can click on for greater detail, shows that at March 2022 Reach Energy Berhad had debt of RM766.8m, up from RM684.6m in one year. On the flip side, it has RM25.1m in cash leading to net debt of about RM741.7m.

How Healthy Is Reach Energy Berhad's Balance Sheet?

We can see from the most recent balance sheet that Reach Energy Berhad had liabilities of RM119.2m falling due within a year, and liabilities of RM830.9m due beyond that. Offsetting these obligations, it had cash of RM25.1m as well as receivables valued at RM12.0m due within 12 months. So its liabilities total RM913.0m more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the RM38.4m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Reach Energy Berhad would probably need a major re-capitalization if its creditors were to demand repayment. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Reach Energy Berhad will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Over 12 months, Reach Energy Berhad reported revenue of RM179m, which is a gain of 124%, although it did not report any earnings before interest and tax. So its pretty obvious shareholders are hoping for more growth!

Caveat Emptor

Despite the top line growth, Reach Energy Berhad still had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost a very considerable RM35m at the EBIT level. Reflecting on this and the significant total liabilities, it's hard to know what to say about the stock because of our intense dis-affinity for it. Sure, the company might have a nice story about how they are going on to a brighter future. But the fact is that it incinerated RM8.1m of cash in the last twelve months, and has precious few liquid assets in comparison to its liabilities. So we consider this a high risk stock, and we're worried its share price could sink faster than than a dingy with a great white shark attacking it. 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. Be aware that Reach Energy Berhad is showing 3 warning signs in our investment analysis , you should know about...

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. 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.