PPB Group Berhad (KLSE:PPB) Has A Somewhat Strained Balance Sheet

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. As with many other companies PPB Group Berhad (KLSE:PPB) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

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What Is PPB Group Berhad's Net Debt?

As you can see below, at the end of June 2022, PPB Group Berhad had RM1.59b of debt, up from RM942.5m a year ago. Click the image for more detail. However, because it has a cash reserve of RM1.55b, its net debt is less, at about RM47.4m.

How Strong Is PPB Group Berhad's Balance Sheet?

We can see from the most recent balance sheet that PPB Group Berhad had liabilities of RM2.43b falling due within a year, and liabilities of RM546.5m due beyond that. On the other hand, it had cash of RM1.55b and RM1.27b worth of receivables due within a year. So its liabilities total RM155.9m more than the combination of its cash and short-term receivables.

This state of affairs indicates that PPB Group Berhad's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the RM23.5b company is short on cash, but still worth keeping an eye on the balance sheet. But either way, PPB Group Berhad has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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.

PPB Group Berhad has a very low debt to EBITDA ratio of 0.20 so it is strange to see weak interest coverage, with last year's EBIT being only 1.9 times the interest expense. So while we're not necessarily alarmed we think that its debt is far from trivial. Notably, PPB Group Berhad made a loss at the EBIT level, last year, but improved that to positive EBIT of RM89m in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if PPB Group Berhad can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, PPB Group Berhad saw substantial negative free cash flow, in total. 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

Both PPB Group Berhad's conversion of EBIT to free cash flow and its interest cover were discouraging. But at least its net debt to EBITDA is a gleaming silver lining to those clouds. Looking at all the angles mentioned above, it does seem to us that PPB Group Berhad 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. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 1 warning sign with PPB Group Berhad , and understanding them should be part of your investment process.

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.