PETRONAS Chemicals Group Berhad (KLSE:PCHEM) Seems To Use Debt Quite Sensibly

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 PETRONAS Chemicals Group Berhad (KLSE:PCHEM) makes use of debt. 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

See 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 June 2024 PETRONAS Chemicals Group Berhad had RM3.35b of debt, an increase on RM2.85b, over one year. However, it does have RM9.41b in cash offsetting this, leading to net cash of RM6.06b.

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 RM9.59b falling due within a year, and liabilities of RM9.28b due beyond that. Offsetting these obligations, it had cash of RM9.41b as well as receivables valued at RM4.96b due within 12 months. So it has liabilities totalling RM4.50b more than its cash and near-term receivables, combined.

Given PETRONAS Chemicals Group Berhad has a humongous market capitalization of RM43.6b, 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.

In fact PETRONAS Chemicals Group Berhad's saving grace is its low debt levels, because its EBIT has tanked 31% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. 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, 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 94% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

Although PETRONAS Chemicals Group Berhad's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of RM6.06b. The cherry on top was that in converted 94% of that EBIT to free cash flow, bringing in RM1.8b. 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. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for PETRONAS Chemicals Group 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.

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.