Is Pets at Home Group (LON:PETS) 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.' 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 Pets at Home Group Plc (LON:PETS) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Pets at Home Group

What Is Pets at Home Group's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Pets at Home Group had UK£45.5m of debt in March 2024, down from UK£120.9m, one year before. However, it does have UK£57.1m in cash offsetting this, leading to net cash of UK£11.6m.

How Strong Is Pets at Home Group's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Pets at Home Group had liabilities of UK£341.2m due within 12 months and liabilities of UK£354.1m due beyond that. On the other hand, it had cash of UK£57.1m and UK£51.2m worth of receivables due within a year. So it has liabilities totalling UK£587.0m more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Pets at Home Group has a market capitalization of UK£1.41b, 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. Despite its noteworthy liabilities, Pets at Home Group boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Pets at Home Group saw its EBIT drop by 8.3% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Pets at Home Group's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Pets at Home Group 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. Over the last three years, Pets at Home Group actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing Up

While Pets at Home Group does have more liabilities than liquid assets, it also has net cash of UK£11.6m. The cherry on top was that in converted 126% of that EBIT to free cash flow, bringing in UK£162m. So we are not troubled with Pets at Home Group's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Pets at Home Group you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.

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