Is Power Root Berhad (KLSE:PWROOT) Using Too Much 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.' 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 Power Root Berhad (KLSE:PWROOT) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Power Root Berhad

What Is Power Root Berhad's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Power Root Berhad had RM35.6m of debt, an increase on RM3.61m, over one year. But it also has RM95.5m in cash to offset that, meaning it has RM59.9m net cash.

How Healthy Is Power Root Berhad's Balance Sheet?

We can see from the most recent balance sheet that Power Root Berhad had liabilities of RM126.5m falling due within a year, and liabilities of RM17.2m due beyond that. Offsetting these obligations, it had cash of RM95.5m as well as receivables valued at RM112.7m due within 12 months. So it actually has RM64.4m more liquid assets than total liabilities.

This short term liquidity is a sign that Power Root Berhad could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Power Root Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Power Root Berhad has boosted its EBIT by 95%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Power Root 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Power Root Berhad has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Power Root Berhad produced sturdy free cash flow equating to 79% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to investigate a company's debt, in this case Power Root Berhad has RM59.9m in net cash and a decent-looking balance sheet. And we liked the look of last year's 95% year-on-year EBIT growth. So we don't think Power Root Berhad's use of debt is risky. 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. For example, we've discovered 1 warning sign for Power Root Berhad that you should be aware of before investing here.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.