These 4 Measures Indicate That Pets at Home Group (LON:PETS) Is Using Debt Reasonably Well

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.' 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. We note that Pets at Home Group Plc (LON:PETS) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Pets at Home Group

How Much Debt Does Pets at Home Group Carry?

You can click the graphic below for the historical numbers, but it shows that as of March 2023 Pets at Home Group had UK£120.9m of debt, an increase on UK£96.9m, over one year. But it also has UK£180.0m in cash to offset that, meaning it has UK£59.1m net cash.

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

The latest balance sheet data shows that Pets at Home Group had liabilities of UK£353.6m due within a year, and liabilities of UK£470.7m falling due after that. On the other hand, it had cash of UK£180.0m and UK£37.1m worth of receivables due within a year. So it has liabilities totalling UK£607.2m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Pets at Home Group is worth UK£1.55b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Pets at Home Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

Pets at Home Group's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. The balance sheet is clearly the area to focus on when you are analysing debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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£59.1m. And it impressed us with free cash flow of UK£176m, being 138% of its EBIT. So we are not troubled with Pets at Home Group'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 instance, we've identified 1 warning sign for Pets at Home Group that you should be aware of.

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.