We Think Prestar Resources Berhad (KLSE:PRESTAR) Is Taking Some Risk With Its Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Prestar Resources Berhad (KLSE:PRESTAR) makes use of debt. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Prestar Resources Berhad

What Is Prestar Resources Berhad's Net Debt?

The chart below, which you can click on for greater detail, shows that Prestar Resources Berhad had RM199.7m in debt in June 2021; about the same as the year before. However, it does have RM40.0m in cash offsetting this, leading to net debt of about RM159.7m.

A Look At Prestar Resources Berhad's Liabilities

Zooming in on the latest balance sheet data, we can see that Prestar Resources Berhad had liabilities of RM220.5m due within 12 months and liabilities of RM27.3m due beyond that. Offsetting these obligations, it had cash of RM40.0m as well as receivables valued at RM111.8m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by RM96.0m.

Prestar Resources Berhad has a market capitalization of RM267.6m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (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 3.1 Prestar Resources Berhad has a fairly noticeable amount of debt. On the plus side, its EBIT was 7.0 times its interest expense, and its net debt to EBITDA, was quite high, at 3.1. We also note that Prestar Resources Berhad improved its EBIT from a last year's loss to a positive RM45m. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Prestar Resources Berhad will need earnings to service that debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Prestar Resources Berhad saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

Mulling over Prestar Resources Berhad's attempt at converting EBIT to free cash flow, we're certainly not enthusiastic. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Prestar Resources Berhad stock 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. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 5 warning signs for Prestar Resources Berhad you should be aware of, and 2 of them make us uncomfortable.

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.
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