Parsons (NYSE:PSN) Has A Rock Solid 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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Parsons Corporation (NYSE:PSN) does carry debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Parsons

What Is Parsons's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2024 Parsons had US$1.25b of debt, an increase on US$744.8m, over one year. On the flip side, it has US$528.5m in cash leading to net debt of about US$718.8m.

How Strong Is Parsons' Balance Sheet?

The latest balance sheet data shows that Parsons had liabilities of US$1.43b due within a year, and liabilities of US$1.49b falling due after that. Offsetting these obligations, it had cash of US$528.5m as well as receivables valued at US$1.85b due within 12 months. So it has liabilities totalling US$544.0m more than its cash and near-term receivables, combined.

Of course, Parsons has a titanic market capitalization of US$11.3b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Parsons has a low net debt to EBITDA ratio of only 1.3. And its EBIT covers its interest expense a whopping 11.7 times over. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that Parsons has boosted its EBIT by 80%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Parsons 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Parsons generated free cash flow amounting to a very robust 99% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

Parsons's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its EBIT growth rate also supports that impression! Considering this range of factors, it seems to us that Parsons is quite prudent with its debt, and the risks seem well managed. So the balance sheet looks pretty healthy, to us. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Parsons you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.