Stock Analysis

Is Primoris Services (NASDAQ:PRIM) A Risky Investment?

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NasdaqGS:PRIM
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David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Primoris Services Corporation (NASDAQ:PRIM) 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

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What Is Primoris Services's Debt?

As you can see below, at the end of June 2021, Primoris Services had US$661.7m of debt, up from US$364.2m a year ago. Click the image for more detail. However, it also had US$178.0m in cash, and so its net debt is US$483.8m.

debt-equity-history-analysis
NasdaqGS:PRIM Debt to Equity History November 8th 2021

How Strong Is Primoris Services' Balance Sheet?

According to the last reported balance sheet, Primoris Services had liabilities of US$758.7m due within 12 months, and liabilities of US$798.6m due beyond 12 months. Offsetting these obligations, it had cash of US$178.0m as well as receivables valued at US$846.9m due within 12 months. So it has liabilities totalling US$532.4m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Primoris Services has a market capitalization of US$1.53b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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).

Primoris Services's net debt to EBITDA ratio of about 1.7 suggests only moderate use of debt. And its strong interest cover of 11.6 times, makes us even more comfortable. Also positive, Primoris Services grew its EBIT by 29% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Primoris Services 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, Primoris Services recorded free cash flow worth 56% 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

Primoris Services's EBIT growth rate suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And that's just the beginning of the good news since its interest cover is also very heartening. Taking all this data into account, it seems to us that Primoris Services takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. 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. For example - Primoris Services has 2 warning signs we think you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

What are the risks and opportunities for Primoris Services?

Primoris Services Corporation, a specialty contractor company, provides a range of construction, fabrication, maintenance, replacement, and engineering services in the United States and Canada.

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Rewards

  • Price-To-Earnings ratio (11.5x) is below the US market (15.5x)

  • Earnings are forecast to grow 12.8% per year

  • Earnings have grown 14.3% per year over the past 5 years

Risks

  • Debt is not well covered by operating cash flow

  • Significant insider selling over the past 3 months

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