Here's Why PETRONAS Chemicals Group Berhad (KLSE:PCHEM) Can Manage Its Debt Responsibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that PETRONAS Chemicals Group Berhad (KLSE:PCHEM) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for PETRONAS Chemicals Group Berhad

How Much Debt Does PETRONAS Chemicals Group Berhad Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2023 PETRONAS Chemicals Group Berhad had RM2.97b of debt, an increase on RM2.72b, over one year. But it also has RM9.27b in cash to offset that, meaning it has RM6.30b net cash.

How Healthy Is PETRONAS Chemicals Group Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that PETRONAS Chemicals Group Berhad had liabilities of RM8.95b due within 12 months and liabilities of RM9.18b due beyond that. Offsetting this, it had RM9.27b in cash and RM3.89b in receivables that were due within 12 months. So its liabilities total RM4.97b more than the combination of its cash and short-term receivables.

Given PETRONAS Chemicals Group Berhad has a humongous market capitalization of RM54.2b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, PETRONAS Chemicals Group Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for PETRONAS Chemicals Group Berhad if management cannot prevent a repeat of the 68% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine PETRONAS Chemicals Group Berhad's ability to maintain a healthy balance sheet going forward. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. PETRONAS Chemicals Group Berhad may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, PETRONAS Chemicals Group Berhad generated free cash flow amounting to a very robust 99% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that PETRONAS Chemicals Group Berhad has RM6.30b in net cash. And it impressed us with free cash flow of RM2.8b, being 99% of its EBIT. So we don't have any problem with PETRONAS Chemicals Group Berhad's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with PETRONAS Chemicals Group Berhad .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.