Warren Buffett said: “Volatility is far from synonymous with risk”. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. Like many other companies Prestar Berhad Resources (KLSE: PRESTAR) uses debt. But should shareholders be concerned about its use of debt?
What risk does debt entail?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are ruthlessly liquidated by their bankers. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. Of course, debt can be an important tool in businesses, especially capital intensive businesses. When we think of a business’s use of debt, we first look at cash flow and debt together.
See our latest review for Prestar Resources Berhad
What is the net debt of Prestar Resources Berhad?
The graph below, which you can click for more details, shows that Prestar Resources Berhad had a debt of RM 199.7 million in June 2021; about the same as the year before. However, he has RM40.0 million in cash offsetting this, which leads to a net debt of around RM 159.7 million.
A look at the liabilities of Prestar Resources Berhad
Zooming in on the latest balance sheet data, we can see that Prestar Resources Berhad had a liability of RM 220.5 million due within 12 months and a liability of RM 27.3 million due beyond. In compensation for these obligations, he had cash of 40.0 million ringgit as well as receivables valued at 111.8 million ringgit within 12 months. Thus, its liabilities exceed the sum of its cash and (short-term) receivables by RM96.0 million.
Prestar Resources Berhad has a market cap of RM267.6million, so it could most likely raise funds to improve its balance sheet, should the need arise. But we absolutely want to keep our eyes open for indications that its debt is too risky.
We measure a company’s debt load relative to its earning capacity by looking at its net debt divided by its earnings before interest, taxes, depreciation, and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT) covers its interest costs (interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).
With a net debt to EBITDA ratio of 3.1 Prestar Resources, Berhad has quite a lot of leverage. On the positive side, its EBIT was 7.0 times its interest expense and its net debt to EBITDA was quite high, at 3.1. We also note that Prestar Resources Berhad improved its EBIT from a loss last year to a positive RM 45 million. When analyzing debt levels, the balance sheet is the obvious starting point. But you can’t look at debt in isolation; since Prestar Resources Berhad will need income to repay this debt. So if you want to know more about its profits, it may be worth checking out this long term profit trend chart.
But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. It is therefore worth checking to what extent earnings before interest and taxes (EBIT) are backed by free cash flow. Over the past year, Prestar Resources Berhad recorded substantial total negative free cash flow. While this may be the result of spending on growth, it makes debt much riskier.
Our point of view
Reflecting on Prestar Resources Berhad’s attempt to convert EBIT into free cash flow, we are certainly not enthusiastic. But on the bright side, his interest coverage is a good sign and makes us more optimistic. Looking at the balance sheet and taking all of these factors into account, we think debt makes Prestar Resources Berhad stock a bit risky. Some people like this kind of risk, but we are aware of the potential pitfalls, so we would probably prefer him to carry less debt. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. Concrete example: we have spotted 5 warning signs for Prestar Resources Berhad you need to be aware of this, and 2 of them make us uncomfortable.
If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash net growth stocks.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St does not have any position in the mentioned stocks.
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