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.' 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. Importantly, PetroChina Company Limited (HKG:857) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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 examine debt levels, we first consider both cash and debt levels, together.

What Is PetroChina's Debt?

As you can see below, PetroChina had CN¥213.8b of debt at June 2024, down from CN¥302.5b a year prior. But it also has CN¥258.8b in cash to offset that, meaning it has CN¥45.0b net cash.

How Healthy Is PetroChina's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that PetroChina had liabilities of CN¥716.6b due within 12 months and liabilities of CN¥373.5b due beyond that. Offsetting these obligations, it had cash of CN¥258.8b as well as receivables valued at CN¥90.1b due within 12 months. So it has liabilities totalling CN¥741.2b more than its cash and near-term receivables, combined.

This deficit isn't so bad because PetroChina is worth a massive CN¥1.49t, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, PetroChina boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that PetroChina has increased its EBIT by 2.7% over twelve months, which should ease any concerns about debt repayment. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if PetroChina can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While PetroChina has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, PetroChina produced sturdy free cash flow equating to 71% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

Although PetroChina's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of CN¥45.0b. And it impressed us with free cash flow of CN¥162b, being 71% of its EBIT. So we don't have any problem with PetroChina's use of debt. 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. Be aware that PetroChina is showing 2 warning signs in our investment analysis , and 1 of those shouldn't be ignored...

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.