These 4 Measures Indicate That Plenitude Berhad (KLSE:PLENITU) Is Using Debt Extensively

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 can see that Plenitude Berhad (KLSE:PLENITU) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Plenitude Berhad

How Much Debt Does Plenitude Berhad Carry?

The chart below, which you can click on for greater detail, shows that Plenitude Berhad had RM135.9m in debt in September 2020; about the same as the year before. But it also has RM197.1m in cash to offset that, meaning it has RM61.2m net cash.

A Look At Plenitude Berhad's Liabilities

Zooming in on the latest balance sheet data, we can see that Plenitude Berhad had liabilities of RM120.7m due within 12 months and liabilities of RM161.6m due beyond that. Offsetting these obligations, it had cash of RM197.1m as well as receivables valued at RM70.8m due within 12 months. So its liabilities total RM14.4m more than the combination of its cash and short-term receivables.

Given Plenitude Berhad has a market capitalization of RM381.5m, 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, Plenitude Berhad also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is just as well that Plenitude Berhad's load is not too heavy, because its EBIT was down 57% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Plenitude Berhad's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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 investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing up

We could understand if investors are concerned about Plenitude Berhad's liabilities, but we can be reassured by the fact it has has net cash of RM61.2m. So while Plenitude Berhad does not have a great balance sheet, it's certainly not too bad. 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. We've identified 4 warning signs with Plenitude Berhad (at least 1 which is concerning) , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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