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 Primoris Services Corporation (NASDAQ:PRIM) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Primoris Services's Debt?
As you can see below, at the end of March 2021, Primoris Services had US$661.5m of debt, up from US$354.6m a year ago. Click the image for more detail. However, it does have US$212.8m in cash offsetting this, leading to net debt of about US$448.7m.
How Strong Is Primoris Services' Balance Sheet?
We can see from the most recent balance sheet that Primoris Services had liabilities of US$796.8m falling due within a year, and liabilities of US$817.3m due beyond that. On the other hand, it had cash of US$212.8m and US$825.4m worth of receivables due within a year. So its liabilities total US$575.9m more than the combination of its cash and short-term receivables.
Primoris Services has a market capitalization of US$1.53b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without 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).
Primoris Services's net debt to EBITDA ratio of about 1.6 suggests only moderate use of debt. And its strong interest cover of 12.1 times, makes us even more comfortable. On top of that, Primoris Services grew its EBIT by 42% over the last twelve months, and that growth will make it easier to handle 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 Primoris Services'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, Primoris Services recorded free cash flow worth 62% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Happily, Primoris Services's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its EBIT growth rate also supports that impression! When we consider the range of factors above, it looks like Primoris Services is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 2 warning signs with Primoris Services , and understanding them should be part of your investment process.
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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Primoris Services Corporation, a specialty contractor company, provides a range of construction, fabrication, maintenance, replacement, and engineering services in the United States and Canada.
Fair value with mediocre balance sheet.