Is Barratt Developments (LON:BDEV) 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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Barratt Developments plc (LON:BDEV) does have debt on its balance sheet. 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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Barratt Developments

What Is Barratt Developments's Net Debt?

The chart below, which you can click on for greater detail, shows that Barratt Developments had UK£202.0m in debt in December 2022; about the same as the year before. But it also has UK£1.17b in cash to offset that, meaning it has UK£964.5m net cash.

How Healthy Is Barratt Developments' Balance Sheet?

We can see from the most recent balance sheet that Barratt Developments had liabilities of UK£1.55b falling due within a year, and liabilities of UK£821.4m due beyond that. Offsetting these obligations, it had cash of UK£1.17b as well as receivables valued at UK£174.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£1.03b.

Barratt Developments has a market capitalization of UK£4.65b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Barratt Developments also has more cash than debt, so we're pretty confident it can manage its debt safely.

Another good sign is that Barratt Developments has been able to increase its EBIT by 24% in twelve months, making it easier to pay down debt. 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 Barratt Developments 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. Barratt Developments may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, Barratt Developments produced sturdy free cash flow equating to 58% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

Although Barratt Developments's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of UK£964.5m. And it impressed us with its EBIT growth of 24% over the last year. So is Barratt Developments's debt a risk? It doesn't seem so to us. 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 Barratt Developments has 4 warning signs (and 1 which doesn't sit too well with us) we think 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.