Is Plenitude Berhad (KLSE:PLENITU) Using Too Much Debt?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Plenitude Berhad (KLSE:PLENITU) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Plenitude Berhad

How Much Debt Does Plenitude Berhad Carry?

As you can see below, at the end of June 2021, Plenitude Berhad had RM369.7m of debt, up from RM139.2m a year ago. Click the image for more detail. However, its balance sheet shows it holds RM476.2m in cash, so it actually has RM106.5m net cash.

A Look At Plenitude Berhad's Liabilities

According to the last reported balance sheet, Plenitude Berhad had liabilities of RM289.3m due within 12 months, and liabilities of RM276.4m due beyond 12 months. Offsetting these obligations, it had cash of RM476.2m as well as receivables valued at RM95.0m due within 12 months. So these liquid assets roughly match the total liabilities.

This state of affairs indicates that Plenitude Berhad's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the RM438.8m company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Plenitude Berhad boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that Plenitude Berhad has seen its EBIT plunge 12% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Plenitude Berhad will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Plenitude 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, Plenitude Berhad burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Plenitude Berhad has net cash of RM106.5m, as well as more liquid assets than liabilities. So we don't have any problem with Plenitude Berhad's use of debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Plenitude Berhad you should be aware of, and 1 of them is potentially serious.

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.

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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