Is PETRONAS Chemicals Group Berhad (KLSE:PCHEM) Using Too Much Debt?

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.' 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 note that PETRONAS Chemicals Group Berhad (KLSE:PCHEM) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. If things get really bad, the lenders can take control of the business. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for PETRONAS Chemicals Group Berhad

How Much Debt Does PETRONAS Chemicals Group Berhad Carry?

The image below, which you can click on for greater detail, shows that at June 2023 PETRONAS Chemicals Group Berhad had debt of RM2.85b, up from RM2.65b in one year. But it also has RM9.06b in cash to offset that, meaning it has RM6.20b net cash.

A Look At PETRONAS Chemicals Group Berhad's Liabilities

We can see from the most recent balance sheet that PETRONAS Chemicals Group Berhad had liabilities of RM7.04b falling due within a year, and liabilities of RM9.34b due beyond that. On the other hand, it had cash of RM9.06b and RM3.74b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM3.58b.

Given PETRONAS Chemicals Group Berhad has a humongous market capitalization of RM56.6b, 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. While it does have liabilities worth noting, PETRONAS Chemicals Group Berhad also has more cash than debt, so we're pretty confident 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 49% 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 ultimately the future profitability of the business will decide if PETRONAS Chemicals 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While PETRONAS Chemicals Group 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, PETRONAS Chemicals Group Berhad generated free cash flow amounting to a very robust 93% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

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 RM6.20b in net cash. And it impressed us with free cash flow of RM4.3b, being 93% of its EBIT. So we don't have any problem with PETRONAS Chemicals Group Berhad's use of debt. 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. Be aware that PETRONAS Chemicals Group Berhad is showing 2 warning signs in our investment analysis , you should know about...

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.