Is PEXA Group (ASX:PXA) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies PEXA Group Limited (ASX:PXA) makes use of debt. But should shareholders be worried about its use of debt?

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When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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 think about a company's use of debt, we first look at cash and debt together.

What Is PEXA Group's Debt?

The image below, which you can click on for greater detail, shows that PEXA Group had debt of AU$309.8m at the end of December 2024, a reduction from AU$368.9m over a year. However, it does have AU$60.6m in cash offsetting this, leading to net debt of about AU$249.2m.

A Look At PEXA Group's Liabilities

According to the last reported balance sheet, PEXA Group had liabilities of AU$62.2m due within 12 months, and liabilities of AU$425.6m due beyond 12 months. Offsetting these obligations, it had cash of AU$60.6m as well as receivables valued at AU$7.68m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$419.5m.

This deficit isn't so bad because PEXA Group is worth AU$1.98b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

View our latest analysis for PEXA Group

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.

PEXA Group has net debt to EBITDA of 4.6 suggesting it uses a fair bit of leverage to boost returns. On the plus side, its EBIT was 7.5 times its interest expense, and its net debt to EBITDA, was quite high, at 4.6. Notably, PEXA Group's EBIT launched higher than Elon Musk, gaining a whopping 528% on last year. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if PEXA Group can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

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. Over the last three years, PEXA Group actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Our View

Happily, PEXA Group's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. But we must concede we find its net debt to EBITDA has the opposite effect. Looking at the bigger picture, we think PEXA Group'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 motivated to research the stock further if we found out that PEXA Group insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.

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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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.