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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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, Primoris Services Corporation (NASDAQ:PRIM) does carry debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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.
How Much Debt Does Primoris Services Carry?
As you can see below, Primoris Services had US$325.8m of debt at December 2020, down from US$357.7m a year prior. However, its balance sheet shows it holds US$326.7m in cash, so it actually has US$982.0k net cash.
How Strong Is Primoris Services' Balance Sheet?
We can see from the most recent balance sheet that Primoris Services had liabilities of US$764.4m falling due within a year, and liabilities of US$490.4m due beyond that. Offsetting these obligations, it had cash of US$326.7m as well as receivables valued at US$740.5m due within 12 months. So its liabilities total US$187.5m more than the combination of its cash and short-term receivables.
Given Primoris Services has a market capitalization of US$1.79b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Primoris Services also has more cash than debt, so we're pretty confident it can manage its debt safely.
And we also note warmly that Primoris Services grew its EBIT by 19% last year, making its debt load easier to handle. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Primoris Services has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Primoris Services produced sturdy free cash flow equating to 64% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Although Primoris Services's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$982.0k. And we liked the look of last year's 19% year-on-year EBIT growth. So is Primoris Services's debt a risk? It doesn't seem so to us. 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. Case in point: We've spotted 2 warning signs for Primoris Services you should be aware of.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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. 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.
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