Is Puncak Niaga Holdings Berhad (KLSE:PUNCAK) A Risky Investment?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that Puncak Niaga Holdings Berhad (KLSE:PUNCAK) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. 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. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Puncak Niaga Holdings Berhad

How Much Debt Does Puncak Niaga Holdings Berhad Carry?

The chart below, which you can click on for greater detail, shows that Puncak Niaga Holdings Berhad had RM1.24b in debt in June 2021; about the same as the year before. On the flip side, it has RM368.2m in cash leading to net debt of about RM876.1m.

How Strong Is Puncak Niaga Holdings Berhad's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Puncak Niaga Holdings Berhad had liabilities of RM470.8m due within 12 months and liabilities of RM1.32b due beyond that. Offsetting these obligations, it had cash of RM368.2m as well as receivables valued at RM185.6m due within 12 months. So it has liabilities totalling RM1.23b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the RM187.8m company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Puncak Niaga Holdings Berhad would probably need a major re-capitalization if its creditors were to demand repayment.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 1.7 times and a disturbingly high net debt to EBITDA ratio of 9.7 hit our confidence in Puncak Niaga Holdings Berhad like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. However, one redeeming factor is that Puncak Niaga Holdings Berhad grew its EBIT at 18% over the last 12 months, boosting its ability to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Puncak Niaga Holdings 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last two years, Puncak Niaga Holdings 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

On the face of it, Puncak Niaga Holdings Berhad's conversion of EBIT to free cash flow left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at growing its EBIT; that's encouraging. It's also worth noting that Puncak Niaga Holdings Berhad is in the Water Utilities industry, which is often considered to be quite defensive. After considering the datapoints discussed, we think Puncak Niaga Holdings Berhad has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 3 warning signs we've spotted with Puncak Niaga Holdings Berhad (including 1 which is a bit unpleasant) .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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