Here's Why Velesto Energy Berhad (KLSE:VELESTO) Can Afford Some Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Velesto Energy Berhad (KLSE:VELESTO) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Velesto Energy Berhad

What Is Velesto Energy Berhad's Debt?

The chart below, which you can click on for greater detail, shows that Velesto Energy Berhad had RM561.2m in debt in December 2022; about the same as the year before. However, it does have RM89.9m in cash offsetting this, leading to net debt of about RM471.4m.

A Look At Velesto Energy Berhad's Liabilities

We can see from the most recent balance sheet that Velesto Energy Berhad had liabilities of RM506.0m falling due within a year, and liabilities of RM310.3m due beyond that. On the other hand, it had cash of RM89.9m and RM359.5m worth of receivables due within a year. So its liabilities total RM367.0m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Velesto Energy Berhad is worth RM1.56b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Velesto Energy 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.

In the last year Velesto Energy Berhad wasn't profitable at an EBIT level, but managed to grow its revenue by 54%, to RM581m. With any luck the company will be able to grow its way to profitability.

Caveat Emptor

While we can certainly appreciate Velesto Energy Berhad's revenue growth, its earnings before interest and tax (EBIT) loss is not ideal. Indeed, it lost RM55m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through RM178m of cash over the last year. So in short it's a really risky stock. 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 Velesto Energy Berhad has 2 warning signs (and 1 which is concerning) we think you should know about.

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.