Permian Resources (NYSE: PR) seems to be using debt quite wisely

Howard Marks said it well when he said that, rather than worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and that every practical investor that I know is worried”. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. We note that Permian Resources Society (NYSE: PR) has debt on its balance sheet. But the more important question is: what risk does this debt create?

What risk does debt carry?

Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. The first step when considering a company’s debt levels is to consider its cash and debt together.

Check out our latest analysis of Permian resources

What is Permian Resources net debt?

The image below, which you can click on for more details, shows that Permian Resources had debt of $801.8 million at the end of June 2022, a reduction from $1.05 billion year-on-year. However, since he has a cash reserve of $201.1 million, his net debt is less, at around $600.8 million.

NYSE: Historical debt-to-equity ratios September 23, 2022

How healthy is Permian Resources’ balance sheet?

According to the latest published balance sheet, Permian Resources had liabilities of US$316.1 million due within 12 months and liabilities of US$938.4 million due beyond 12 months. In compensation for these obligations, it had cash of US$201.1 million as well as receivables valued at US$141.6 million and maturing within 12 months. Thus, its liabilities outweigh the sum of its cash and receivables (current) by $911.8 million.

Permian Resources has a market capitalization of $1.96 billion, so it could very likely raise funds to improve its balance sheet, should the need arise. But we definitely want to keep our eyes peeled for indications that its debt is too risky.

In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).

With net debt of just 0.74x EBITDA, Permian Resources is arguably quite conservative. And it has interest coverage of 8.6 times, which is more than enough. It was also good to see that despite losing money on the EBIT line last year, Permian Resources turned things around over the last 12 months, delivering an EBIT of US$484 million. The balance sheet is clearly the area to focus on when analyzing debt. But it is future earnings, more than anything, that will determine Permian Resources’ ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.

But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. It is therefore important to check how much of its earnings before interest and taxes (EBIT) converts into actual free cash flow. Over the past year, Permian Resources has produced strong free cash flow equivalent to 77% of its EBIT, which is what we expected. This free cash flow puts the company in a good position to repay its debt, should it arise.

Our point of view

Permian Resources’ conversion of EBIT to free cash flow suggests it can manage its debt as easily as Cristiano Ronaldo could score a goal against an Under-14 goalkeeper. But truth be told, we think his total passive level undermines that impression a bit. All told, it looks like Permian Resources can comfortably manage its current level of debt. On the plus side, this leverage can increase shareholder returns, but the potential downside is more risk of loss, so it’s worth keeping an eye on the balance sheet. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist outside of the balance sheet. Be aware that Permian Resources displays 2 warning signs in our investment analysis you should know…

If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

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