PAM Transportation Services (NASDAQ:PTSI) appears to be using debt sparingly

Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The greatest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. Like many other companies PAM Transportation Services, Inc. (NASDAQ:PTSI) uses debt. But the real question is whether this debt makes the business risky.

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. However, a more usual (but still expensive) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, many companies use debt to finance their growth, without any negative consequences. The first step when considering a company’s debt levels is to consider its cash and debt together.

Check out our latest analysis for PAM Transportation Services

How much debt does PAM Transportation Services have?

As you can see below, PAM Transportation Services had a debt of US$260.4 million in March 2022, compared to US$280.4 million the previous year. However, he has $118.7 million in cash to offset this, resulting in a net debt of approximately $141.6 million.

NasdaqGM: PTSI Debt to Equity History May 20, 2022

How strong is PAM Transportation Services’ balance sheet?

We can see from the most recent balance sheet that PAM Transportation Services had liabilities of US$128.8 million due within one year, and liabilities of US$297.7 million due beyond . In return, it had $118.7 million in cash and $143.2 million in receivables due within 12 months. Thus, its liabilities outweigh the sum of its cash and receivables (current) by $164.5 million.

This shortfall isn’t that bad because PAM Transportation Services is worth $585.6 million and therefore could probably raise enough capital to shore up its balance sheet, should the need arise. But it is clear that it is essential to examine closely whether it can manage its debt without dilution.

We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.

PAM Transportation Services’ net debt is only 0.82 times its EBITDA. And its EBIT covers its interest charges 19.3 times. So we’re pretty relaxed about his super-conservative use of debt. What is even more impressive is that PAM Transportation Services increased its EBIT by 203% year-over-year. If sustained, this growth will make debt even more manageable in years to come. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether PAM Transportation Services can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

Finally, a business needs free cash flow to pay off its debts; book profits are not enough. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, PAM Transportation Services has recorded free cash flow of 75% of its EBIT, which is about normal, given that free cash flow excludes interest and taxes. This cold hard cash allows him to reduce his debt whenever he wants.

Our point of view

The good news is that PAM Transportation Services’ demonstrated ability to cover its interest costs with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, since its EBIT growth rate also confirms this impression! Zooming out, PAM Transportation Services appears to be using debt quite sensibly; and that gets the green light from us. After all, reasonable leverage can increase return on equity. 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. These risks can be difficult to spot. Every business has them, and we’ve spotted 3 warning signs for PAM Transportation Services (1 of which makes us a little uncomfortable!) that you should know.

Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.

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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