Is Reach Energy Berhad (KLSE:REACH) Using Debt In A Risky Way?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Reach Energy Berhad (KLSE:REACH) does use debt in its business. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Reach Energy Berhad

What Is Reach Energy Berhad's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2022 Reach Energy Berhad had RM836.0m of debt, an increase on RM763.0m, over one year. And it doesn't have much cash, so its net debt is about the same.

A Look At Reach Energy Berhad's Liabilities

We can see from the most recent balance sheet that Reach Energy Berhad had liabilities of RM579.4m falling due within a year, and liabilities of RM571.5m due beyond that. Offsetting this, it had RM10.6m in cash and RM4.39m in receivables that were due within 12 months. So its liabilities total RM1.14b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the RM54.8m 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 definitely think shareholders need to watch this one closely. After all, Reach Energy Berhad would likely require a major re-capitalisation if it had to pay its creditors today. When analysing debt levels, the balance sheet is the obvious place to start. 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 RM169m, which is a gain of 12%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Over the last twelve months Reach Energy Berhad produced an earnings before interest and tax (EBIT) loss. Its EBIT loss was a whopping RM72m. 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. Like every long-shot we're sure it has a glossy presentation outlining its blue-sky potential. But the reality is that it is low on liquid assets relative to liabilities, and it burned through RM17m in the last year. 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. 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 instance, we've identified 4 warning signs for Reach Energy Berhad (3 are concerning) you should be aware of.

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.