Does Par Pacific Holdings (NYSE:PARR) Have A Healthy Balance Sheet?

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.' 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 Par Pacific Holdings, Inc. (NYSE:PARR) does use debt in its business. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Par Pacific Holdings

What Is Par Pacific Holdings's Net Debt?

As you can see below, Par Pacific Holdings had US$505.5m of debt at December 2022, down from US$564.6m a year prior. However, it also had US$490.9m in cash, and so its net debt is US$14.6m.

How Healthy Is Par Pacific Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Par Pacific Holdings had liabilities of US$1.79b due within 12 months and liabilities of US$842.0m due beyond that. Offsetting these obligations, it had cash of US$490.9m as well as receivables valued at US$252.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$1.89b.

Given this deficit is actually higher than the company's market capitalization of US$1.72b, we think shareholders really should watch Par Pacific Holdings's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. Par Pacific Holdings has a very little net debt but plenty of other liabilities weighing it down.

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.

Par Pacific Holdings has very modest net debt, giving rise to a debt to EBITDA ratio of 0.027. And EBIT easily covered the interest expense 8.5 times over, lending force to that view. Although Par Pacific Holdings made a loss at the EBIT level, last year, it was also good to see that it generated US$442m in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Par Pacific Holdings'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Over the last year, Par Pacific Holdings recorded free cash flow worth a fulsome 90% 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

Both Par Pacific Holdings's ability to to convert EBIT to free cash flow and its net debt to EBITDA gave us comfort that it can handle its debt. In contrast, our confidence was undermined by its apparent struggle to handle its total liabilities. When we consider all the elements mentioned above, it seems to us that Par Pacific Holdings is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Par Pacific Holdings is showing 2 warning signs in our investment analysis , and 1 of those is potentially serious...

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.