Here's Why Prestar Resources Berhad (KLSE:PRESTAR) Has A Meaningful Debt Burden

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.' 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. As with many other companies Prestar Resources Berhad (KLSE:PRESTAR) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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. 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, at the end of September 2021, Prestar Resources Berhad had RM233.4m of debt, up from RM162.9m a year ago. Click the image for more detail. On the flip side, it has RM50.4m in cash leading to net debt of about RM183.0m.

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 RM261.4m due within 12 months and liabilities of RM26.2m due beyond that. Offsetting these obligations, it had cash of RM50.4m as well as receivables valued at RM72.0m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM165.2m.

This deficit is considerable relative to its market capitalization of RM219.5m, so it does suggest shareholders should keep an eye on Prestar Resources Berhad's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

With net debt to EBITDA of 2.7 Prestar Resources Berhad has a fairly noticeable amount of debt. But the high interest coverage of 9.2 suggests it can easily service that debt. We also note that Prestar Resources Berhad improved its EBIT from a last year's loss to a positive RM60m. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Prestar Resources Berhad's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. Over the last year, Prestar Resources Berhad saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

We'd go so far as to say Prestar Resources Berhad's conversion of EBIT to free cash flow was disappointing. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that Prestar Resources Berhad's debt is making it a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less 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. These risks can be hard to spot. Every company has them, and we've spotted 5 warning signs for Prestar Resources Berhad (of which 2 are potentially serious!) you should know about.

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.

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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.