We Think Berkeley Group Holdings (LON:BKG) Can Stay On Top Of Its 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.' 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 The Berkeley Group Holdings plc (LON:BKG) makes use of 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Berkeley Group Holdings

What Is Berkeley Group Holdings's Debt?

As you can see below, at the end of April 2022, Berkeley Group Holdings had UK£660.0m of debt, up from UK£300.0m a year ago. Click the image for more detail. However, its balance sheet shows it holds UK£928.9m in cash, so it actually has UK£268.9m net cash.

How Healthy Is Berkeley Group Holdings' Balance Sheet?

According to the last reported balance sheet, Berkeley Group Holdings had liabilities of UK£1.97b due within 12 months, and liabilities of UK£1.48b due beyond 12 months. Offsetting this, it had UK£928.9m in cash and UK£150.2m in receivables that were due within 12 months. So it has liabilities totalling UK£2.37b more than its cash and near-term receivables, combined.

Berkeley Group Holdings has a market capitalization of UK£4.48b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Berkeley Group Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

While Berkeley Group Holdings doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Berkeley Group Holdings 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 Berkeley Group Holdings 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. Looking at the most recent three years, Berkeley Group Holdings recorded free cash flow of 33% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

Although Berkeley Group Holdings'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£268.9m. So we are not troubled with Berkeley Group Holdings's debt use. 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. We've identified 2 warning signs with Berkeley Group Holdings , and understanding them should be part of your investment process.

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.