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

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Puncak Niaga Holdings Berhad (KLSE:PUNCAK) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its 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 RM1.22b in debt in September 2022; about the same as the year before. However, because it has a cash reserve of RM296.8m, its net debt is less, at about RM919.9m.

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

We can see from the most recent balance sheet that Puncak Niaga Holdings Berhad had liabilities of RM390.4m falling due within a year, and liabilities of RM1.30b due beyond that. Offsetting this, it had RM296.8m in cash and RM187.2m in receivables that were due within 12 months. So its liabilities total RM1.21b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the RM123.0m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Puncak Niaga Holdings Berhad would likely require a major re-capitalisation if it had to pay its creditors today.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 1.2 times and a disturbingly high net debt to EBITDA ratio of 10.0 hit our confidence in Puncak Niaga Holdings Berhad like a one-two punch to the gut. The debt burden here is substantial. Fortunately, Puncak Niaga Holdings Berhad grew its EBIT by 8.6% in the last year, slowly shrinking its debt relative to earnings. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Puncak Niaga Holdings Berhad will need earnings to service that debt. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three 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

To be frank both Puncak Niaga Holdings Berhad's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. 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. Taking into account all the aforementioned factors, it looks like Puncak Niaga Holdings Berhad has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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. To that end, you should be aware of the 2 warning signs we've spotted with Puncak Niaga Holdings Berhad .

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.

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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.