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.’ So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Parsons Corporation (NYSE:PSN) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. 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. When we examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for Parsons
How Much Debt Does Parsons Carry?
The image below, which you can click on for greater detail, shows that at September 2022 Parsons had debt of US$694.7m, up from US$591.4m in one year. However, it also had US$147.5m in cash, and so its net debt is US$547.2m.
How Strong Is Parsons’ Balance Sheet?
The latest balance sheet data shows that Parsons had liabilities of US$1.15b due within a year, and liabilities of US$940.4m falling due after that. Offsetting this, it had US$147.5m in cash and US$1.35b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$589.4m.
Since publicly traded Parsons shares are worth a total of US$4.47b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it’s clear that we should continue to monitor its balance sheet, lest it change for the worse.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Parsons’s net debt of 1.9 times EBITDA suggests graceful use of debt. And the alluring interest cover (EBIT of 9.1 times interest expense) certainly does not do anything to dispel this impression. It is well worth noting that Parsons’s EBIT shot up like bamboo after rain, gaining 68% in the last twelve months. That’ll make it easier to manage its debt. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Happily for any shareholders, Parsons actually produced more free cash flow than EBIT over the last three years. There’s nothing better than incoming cash when it comes to staying in your lenders’ good graces.
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 that’s just the beginning of the good news since its EBIT growth rate is also very heartening. Looking at the bigger picture, we think Parsons’s use of debt seems quite reasonable and we’re not concerned about it. After all, sensible leverage can boost returns on equity. We’d be very excited to see if Parsons insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.
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.
What are the risks and opportunities for Parsons?
Parsons Corporation provides integrated solutions and services in the defense, intelligence, and critical infrastructure markets in North America, the Middle East, and internationally.
Rewards
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Trading at 31% below our estimate of its fair value
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Earnings are forecast to grow 23.9% per year
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Earnings grew by 71.9% over the past year
Risks
No risks detected for PSN from our risks checks.
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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.
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