Puncak Niaga Holdings Berhad (KLSE:PUNCAK) Seems To Be Using A Lot Of Debt

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 assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Puncak Niaga Holdings Berhad

What Is Puncak Niaga Holdings Berhad's Net Debt?

The chart below, which you can click on for greater detail, shows that Puncak Niaga Holdings Berhad had RM1.25b in debt in December 2020; about the same as the year before. However, because it has a cash reserve of RM330.7m, its net debt is less, at about RM915.8m.

A Look At Puncak Niaga Holdings Berhad's Liabilities

According to the last reported balance sheet, Puncak Niaga Holdings Berhad had liabilities of RM458.0m due within 12 months, and liabilities of RM1.34b due beyond 12 months. On the other hand, it had cash of RM330.7m and RM113.4m worth of receivables due within a year. So its liabilities total RM1.35b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the RM230.3m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Weak interest cover of 1.4 times and a disturbingly high net debt to EBITDA ratio of 11.9 hit our confidence in Puncak Niaga Holdings Berhad like a one-two punch to the gut. The debt burden here is substantial. Looking on the bright side, Puncak Niaga Holdings Berhad boosted its EBIT by a silky 35% in the last year. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Puncak Niaga Holdings 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last two years, Puncak Niaga Holdings Berhad saw substantial negative free cash flow, in total. 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.

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 on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. We should also note that Water Utilities industry companies like Puncak Niaga Holdings Berhad commonly do use debt without problems. We're quite clear that we consider Puncak Niaga Holdings Berhad to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 4 warning signs for Puncak Niaga Holdings Berhad (1 is a bit unpleasant) you should be aware of.

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.

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