These 4 Measures Indicate That PETRONAS Gas Berhad (KLSE:PETGAS) Is Using Debt Safely

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.' 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. We can see that PETRONAS Gas Berhad (KLSE:PETGAS) does use debt in its business. But the real question is whether this debt is making the company risky.

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for PETRONAS Gas Berhad

What Is PETRONAS Gas Berhad's Net Debt?

As you can see below, PETRONAS Gas Berhad had RM2.05b of debt at September 2021, down from RM2.25b a year prior. But it also has RM3.84b in cash to offset that, meaning it has RM1.79b net cash.

A Look At PETRONAS Gas Berhad's Liabilities

Zooming in on the latest balance sheet data, we can see that PETRONAS Gas Berhad had liabilities of RM1.03b due within 12 months and liabilities of RM4.61b due beyond that. Offsetting this, it had RM3.84b in cash and RM824.1m in receivables that were due within 12 months. So it has liabilities totalling RM976.3m more than its cash and near-term receivables, combined.

Since publicly traded PETRONAS Gas Berhad shares are worth a total of RM33.8b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, PETRONAS Gas Berhad also has more cash than debt, so we're pretty confident it can manage its debt safely.

Fortunately, PETRONAS Gas Berhad grew its EBIT by 2.9% in the last year, making that debt load look even more manageable. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if PETRONAS Gas Berhad can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While PETRONAS Gas 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, PETRONAS Gas Berhad generated free cash flow amounting to a very robust 89% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing up

We could understand if investors are concerned about PETRONAS Gas Berhad's liabilities, but we can be reassured by the fact it has has net cash of RM1.79b. The cherry on top was that in converted 89% of that EBIT to free cash flow, bringing in RM2.1b. So we don't think PETRONAS Gas Berhad's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example PETRONAS Gas Berhad has 2 warning signs (and 1 which is a bit unpleasant) we think you should know about.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.