Parkland Fuel (TSE:PKI) Has A Pretty Healthy Balance Sheet

Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. We note that Parkland Fuel Corporation (TSE:PKI) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company’s debt levels is to consider its cash and debt together.

View our latest analysis for Parkland Fuel

What Is Parkland Fuel’s Debt?

The image below, which you can click on for greater detail, shows that at June 2019 Parkland Fuel had debt of CA$3.30b, up from CA$2.05b in one year. However, it also had CA$330.0m in cash, and so its net debt is CA$2.97b.

TSX:PKI Historical Debt, August 5th 2019
TSX:PKI Historical Debt, August 5th 2019

A Look At Parkland Fuel’s Liabilities

We can see from the most recent balance sheet that Parkland Fuel had liabilities of CA$1.92b falling due within a year, and liabilities of CA$4.96b due beyond that. Offsetting this, it had CA$330.0m in cash and CA$1.11b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$5.43b.

This is a mountain of leverage relative to its market capitalization of CA$6.43b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). 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).

Parkland Fuel’s debt is 2.5 times its EBITDA, and its EBIT cover its interest expense 3.5 times over. This suggests that while the debt levels are significant, we’d stop short of calling them problematic. It is well worth noting that Parkland Fuel’s EBIT shot up like bamboo after rain, gaining 85% in the last twelve months. That’ll make it easier to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Parkland Fuel’s ability to maintain a healthy balance sheet going forward. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Parkland Fuel recorded free cash flow worth 57% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

When it comes to the balance sheet, the standout positive for Parkland Fuel was the fact that it seems able to grow its EBIT confidently. However, our other observations weren’t so heartening. For example, its level of total liabilities makes us a little nervous about its debt. When we consider all the factors mentioned above, we do feel a bit cautious about Parkland Fuel’s use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. Of course, we wouldn’t say no to the extra confidence that we’d gain if we knew that Parkland Fuel insiders have been buying shares: if you’re on the same wavelength, you can find out if insiders are buying by clicking this link.

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.

Discounted cash flow calculation for every stock

Simply Wall St does a detailed discounted cash flow calculation every 6 hours for every stock on the market, so if you want to find the intrinsic value of any company just search here. It’s FREE.