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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.' 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. Importantly, Par Pacific Holdings, Inc. (NYSE:PARR) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Par Pacific Holdings Carry?
As you can see below, at the end of June 2019, Par Pacific Holdings had US$645.6m of debt, up from US$394.4m a year ago. Click the image for more detail. However, because it has a cash reserve of US$106.2m, its net debt is less, at about US$539.4m.
A Look At Par Pacific Holdings's Liabilities
Zooming in on the latest balance sheet data, we can see that Par Pacific Holdings had liabilities of US$974.2m due within 12 months and liabilities of US$1.04b due beyond that. Offsetting this, it had US$106.2m in cash and US$254.7m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$1.65b.
This deficit casts a shadow over the US$1.10b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Par Pacific Holdings would probably need a major re-capitalization if its creditors were to demand repayment.
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.
While Par Pacific Holdings's debt to EBITDA ratio (3.0) suggests that it uses some debt, its interest cover is very weak, at 2.1, suggesting high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. The good news is that Par Pacific Holdings improved its EBIT by 5.4% over the last twelve years, thus gradually reducing its debt levels relative to its earnings. When analysing debt levels, the balance sheet is the obvious place to start. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Par Pacific Holdings's free cash flow amounted to 33% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
To be frank both Par Pacific Holdings's interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least its EBIT growth rate is not so bad. We're quite clear that we consider Par Pacific Holdings to be really rather risky, as a result of its balance sheet health. So we're almost as wary of this stock as a hungry kitten is about falling into its owner's fish pond: once bitten, twice shy, as they say. Over time, share prices tend to follow earnings per share, so if you're interested in Par Pacific Holdings, you may well want to click here to check an interactive graph of its earnings per share history.
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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