Is Pet Center Comércio e Participações (BVMF:PETZ3) A Risky Investment?

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. As with many other companies Pet Center Comércio e Participações S.A. (BVMF:PETZ3) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

View our latest analysis for Pet Center Comércio e Participações

How Much Debt Does Pet Center Comércio e Participações Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2023 Pet Center Comércio e Participações had R$456.4m of debt, an increase on R$127.9m, over one year. But it also has R$471.8m in cash to offset that, meaning it has R$15.3m net cash.

How Healthy Is Pet Center Comércio e Participações' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Pet Center Comércio e Participações had liabilities of R$721.7m due within 12 months and liabilities of R$1.45b due beyond that. On the other hand, it had cash of R$471.8m and R$497.2m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by R$1.20b.

This deficit is considerable relative to its market capitalization of R$1.56b, so it does suggest shareholders should keep an eye on Pet Center Comércio e Participações' use of debt. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. Despite its noteworthy liabilities, Pet Center Comércio e Participações boasts net cash, so it's fair to say it does not have a heavy debt load!

Unfortunately, Pet Center Comércio e Participações saw its EBIT slide 2.6% in the last twelve months. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Pet Center Comércio e Participações 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Pet Center Comércio e Participações has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Pet Center Comércio e Participações burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Summing Up

Although Pet Center Comércio e Participações's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of R$15.3m. Despite its cash we think that Pet Center Comércio e Participações seems to struggle to convert EBIT to free cash flow, so we are wary of the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Pet Center Comércio e Participações that you should be aware of before investing here.

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

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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.