Does Prestar Resources Berhad (KLSE:PRESTAR) Have A Healthy Balance Sheet?

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. We note that Prestar Resources Berhad (KLSE:PRESTAR) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. 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. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Prestar Resources Berhad

What Is Prestar Resources Berhad's Net Debt?

As you can see below, Prestar Resources Berhad had RM163.6m of debt, at March 2021, which is about the same as the year before. You can click the chart for greater detail. However, because it has a cash reserve of RM31.2m, its net debt is less, at about RM132.4m.

How Healthy Is Prestar Resources Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Prestar Resources Berhad had liabilities of RM186.8m due within 12 months and liabilities of RM29.2m due beyond that. Offsetting these obligations, it had cash of RM31.2m as well as receivables valued at RM131.4m due within 12 months. So its liabilities total RM53.4m more than the combination of its cash and short-term receivables.

Given Prestar Resources Berhad has a market capitalization of RM275.5m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Prestar Resources Berhad has a debt to EBITDA ratio of 2.7 and its EBIT covered its interest expense 5.7 times. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. Notably, Prestar Resources Berhad made a loss at the EBIT level, last year, but improved that to positive EBIT of RM41m in the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is Prestar Resources Berhad's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the most recent year, Prestar Resources Berhad recorded free cash flow worth 52% 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.

Our View

Both Prestar Resources Berhad's ability to to convert EBIT to free cash flow and its level of total liabilities gave us comfort that it can handle its debt. On the other hand, its net debt to EBITDA makes us a little less comfortable about its debt. When we consider all the factors mentioned above, we do feel a bit cautious about Prestar Resources Berhad's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 4 warning signs for Prestar Resources Berhad (of which 2 shouldn't be ignored!) you should know about.

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. 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.
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