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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. As with many other companies. Tutor Perini Corporation (NYSE:TPC) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 Tutor Perini’s Debt?
As you can see below, at the end of March 2019, Tutor Perini had US$898.6m of debt, up from US$817.3m a year ago. Click the image for more detail. However, it also had US$101.5m in cash, and so its net debt is US$797.1m.
How Healthy Is Tutor Perini’s Balance Sheet?
According to the last reported balance sheet, Tutor Perini had liabilities of US$1.58b due within 12 months, and liabilities of US$1.18b due beyond 12 months. Offsetting this, it had US$101.5m in cash and US$3.01b in receivables that were due within 12 months. So it actually has US$347.1m more liquid assets than total liabilities.
This surplus liquidity suggests that Tutor Perini’s balance sheet could take a hit just as well as Homer Simpson’s head can take a punch. Having regard to this fact, we think its balance sheet is just as strong as misogynists are weak. Because it carries more debt than cash, we think it’s worth watching Tutor Perini’s balance sheet over time.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Tutor Perini’s debt is only 2.99 times its EBITDA, and its EBIT cover its interest expense 3.32 times over. This suggests that while the debt levels are significant, we’d stop short of calling them problematic. The good news is that Tutor Perini grew its EBIT a smooth 52% over the last twelve months. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. 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 Tutor Perini can strengthen its balance sheet over time. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
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, Tutor Perini reported free cash flow worth 4.5% of its EBIT, which is really quite low. That limp level of cash conversion undermines its ability to manage and pay down debt.
Happily, Tutor Perini’s impressive EBIT growth rate implies it has the upper hand on its debt. But the stark truth is that we are concerned by its conversion of EBIT to free cash flow. When we consider the range of factors above, it looks like Tutor Perini 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. Of course, we wouldn’t say no to the extra confidence that we’d gain if we knew that Tutor Perini 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.
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If you spot an error that warrants correction, please contact the editor at email@example.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.