Is PETRONAS Chemicals Group Berhad (KLSE:PCHEM) A Risky Investment?

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.' 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. 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.

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for PETRONAS Chemicals Group Berhad

What Is PETRONAS Chemicals Group Berhad's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 PETRONAS Chemicals Group Berhad had RM2.19b of debt, an increase on RM2.09b, over one year. But it also has RM12.6b in cash to offset that, meaning it has RM10.4b 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 RM3.01b due within 12 months and liabilities of RM5.43b due beyond that. Offsetting this, it had RM12.6b in cash and RM1.72b in receivables that were due within 12 months. So it actually has RM5.84b more liquid assets than total liabilities.

This short term liquidity is a sign that PETRONAS Chemicals Group Berhad could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that PETRONAS Chemicals Group Berhad has more cash than debt is arguably a good indication that it can manage its debt safely.

The modesty of its debt load may become crucial for PETRONAS Chemicals Group Berhad if management cannot prevent a repeat of the 60% cut to EBIT over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. 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 PETRONAS Chemicals Group 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. 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. Over the most recent three years, PETRONAS Chemicals Group Berhad recorded free cash flow worth 72% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that PETRONAS Chemicals Group Berhad has net cash of RM10.4b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of RM1.5b, being 72% of its EBIT. So we are not troubled with PETRONAS Chemicals Group Berhad's debt use. 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. For instance, we've identified 2 warning signs for PETRONAS Chemicals Group Berhad that 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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