Does Public Service Enterprise Group (NYSE:PEG) Have A Healthy Balance Sheet?

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.' 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. Importantly, Public Service Enterprise Group Incorporated (NYSE:PEG) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Public Service Enterprise Group

What Is Public Service Enterprise Group's Debt?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 Public Service Enterprise Group had US$21.0b of debt, an increase on US$17.1b, over one year. However, it does have US$2.21b in cash offsetting this, leading to net debt of about US$18.8b.

How Healthy Is Public Service Enterprise Group's Balance Sheet?

According to the last reported balance sheet, Public Service Enterprise Group had liabilities of US$7.93b due within 12 months, and liabilities of US$28.2b due beyond 12 months. Offsetting this, it had US$2.21b in cash and US$2.22b in receivables that were due within 12 months. So it has liabilities totalling US$31.8b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its very significant market capitalization of US$34.5b, so it does suggest shareholders should keep an eye on Public Service Enterprise Group's use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

With a net debt to EBITDA ratio of 6.7, it's fair to say Public Service Enterprise Group does have a significant amount of debt. However, its interest coverage of 3.1 is reasonably strong, which is a good sign. Worse, Public Service Enterprise Group's EBIT was down 29% over the last year. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Public Service Enterprise Group's ability to maintain a healthy balance sheet going forward. 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 company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Public Service Enterprise Group burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Public Service Enterprise Group's conversion of EBIT to free cash flow and its track record of (not) growing its EBIT make us rather uncomfortable with its debt levels. And furthermore, its interest cover also fails to instill confidence. We should also note that Integrated Utilities industry companies like Public Service Enterprise Group commonly do use debt without problems. After considering the datapoints discussed, we think Public Service Enterprise Group has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. 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. Be aware that Public Service Enterprise Group is showing 2 warning signs in our investment analysis , you should know about...

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.