Is Barratt Developments (LON:BDEV) Using Too Much Debt?

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.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Barratt Developments plc (LON:BDEV) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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 step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Barratt Developments

What Is Barratt Developments's Debt?

The image below, which you can click on for greater detail, shows that at June 2022 Barratt Developments had debt of UK£217.3m, up from UK£205.3m in one year. However, it does have UK£1.35b in cash offsetting this, leading to net cash of UK£1.14b.

How Healthy Is Barratt Developments' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Barratt Developments had liabilities of UK£1.71b due within 12 months and liabilities of UK£871.8m due beyond that. Offsetting these obligations, it had cash of UK£1.35b as well as receivables valued at UK£227.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£999.3m.

While this might seem like a lot, it is not so bad since Barratt Developments has a market capitalization of UK£3.97b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. 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.

And we also note warmly that Barratt Developments grew its EBIT by 16% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. 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 52% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While Barratt Developments does have more liabilities than liquid assets, it also has net cash of UK£1.14b. And it impressed us with its EBIT growth of 16% over the last year. So we are not troubled with Barratt Developments's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 2 warning signs for Barratt Developments 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.