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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Quanta Services, Inc. (NYSE:PWR) does carry debt. But should shareholders be worried about its use of debt?

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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

How Much Debt Does Quanta Services Carry?

You can click the graphic below for the historical numbers, but it shows that Quanta Services had US$3.67b of debt in March 2024, down from US$4.11b, one year before. However, because it has a cash reserve of US$531.1m, its net debt is less, at about US$3.14b.

How Strong Is Quanta Services' Balance Sheet?

According to the last reported balance sheet, Quanta Services had liabilities of US$4.83b due within 12 months, and liabilities of US$4.34b due beyond 12 months. Offsetting these obligations, it had cash of US$531.1m as well as receivables valued at US$5.37b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$3.27b.

Since publicly traded Quanta Services shares are worth a very impressive total of US$39.2b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

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.

Quanta Services's net debt is sitting at a very reasonable 1.8 times its EBITDA, while its EBIT covered its interest expense just 6.6 times last year. While these numbers do not alarm us, it's worth noting that the cost of the company's debt is having a real impact. Importantly, Quanta Services grew its EBIT by 32% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Quanta Services'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, 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. During the last three years, Quanta Services generated free cash flow amounting to a very robust 83% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Happily, Quanta Services's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. 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 Quanta Services's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Quanta Services you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com