Health Check: How Prudently Does Petro-king Oilfield Services (HKG:2178) Use 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.' 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 Petro-king Oilfield Services Limited (HKG:2178) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Petro-king Oilfield Services

What Is Petro-king Oilfield Services's Debt?

As you can see below, Petro-king Oilfield Services had HK$179.2m of debt at June 2024, down from HK$206.4m a year prior. On the flip side, it has HK$52.7m in cash leading to net debt of about HK$126.6m.

How Strong Is Petro-king Oilfield Services' Balance Sheet?

We can see from the most recent balance sheet that Petro-king Oilfield Services had liabilities of HK$434.5m falling due within a year, and liabilities of HK$66.4m due beyond that. On the other hand, it had cash of HK$52.7m and HK$354.9m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by HK$93.4m.

This is a mountain of leverage relative to its market capitalization of HK$108.8m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. There's no doubt that we learn most about debt from the balance sheet. But you can't view debt in total isolation; since Petro-king Oilfield Services 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.

In the last year Petro-king Oilfield Services wasn't profitable at an EBIT level, but managed to grow its revenue by 8.4%, to HK$379m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Importantly, Petro-king Oilfield Services had an earnings before interest and tax (EBIT) loss over the last year. Its EBIT loss was a whopping HK$13m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. So we think its balance sheet is a little strained, though not beyond repair. Another cause for caution is that is bled HK$26m in negative free cash flow over the last twelve months. So in short it's a really risky stock. When analysing debt levels, the balance sheet is the obvious place to start. 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 Petro-king Oilfield Services .

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.