Does PGS (OB:PGS) Have A Healthy Balance Sheet?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 can see that PGS ASA (OB:PGS) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for PGS

What Is PGS's Net Debt?

You can click the graphic below for the historical numbers, but it shows that PGS had US$780.8m of debt in March 2023, down from US$1.14b, one year before. However, because it has a cash reserve of US$154.1m, its net debt is less, at about US$626.7m.

A Look At PGS' Liabilities

The latest balance sheet data shows that PGS had liabilities of US$601.8m due within a year, and liabilities of US$657.2m falling due after that. On the other hand, it had cash of US$154.1m and US$265.3m worth of receivables due within a year. So its liabilities total US$839.6m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the US$499.4m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, PGS would probably need a major re-capitalization if its creditors were to demand repayment.

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).

PGS has a very low debt to EBITDA ratio of 1.5 so it is strange to see weak interest coverage, with last year's EBIT being only 1.9 times the interest expense. So while we're not necessarily alarmed we think that its debt is far from trivial. Notably, PGS's EBIT launched higher than Elon Musk, gaining a whopping 185% on last year. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if PGS 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, a company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, PGS recorded free cash flow worth a fulsome 98% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

We feel some trepidation about PGS's difficulty level of total liabilities, but we've got positives to focus on, too. To wit both its conversion of EBIT to free cash flow and EBIT growth rate were encouraging signs. Looking at all the angles mentioned above, it does seem to us that PGS is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for PGS you should know about.

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.