We Think Pets at Home Group (LON:PETS) Can Manage Its Debt With Ease

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.' 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. Importantly, Pets at Home Group Plc (LON:PETS) does carry debt. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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 Pets at Home Group

How Much Debt Does Pets at Home Group Carry?

As you can see below, Pets at Home Group had UK£96.9m of debt, at March 2022, which is about the same as the year before. You can click the chart for greater detail. But it also has UK£166.0m in cash to offset that, meaning it has UK£69.1m net cash.

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

According to the last reported balance sheet, Pets at Home Group had liabilities of UK£309.6m due within 12 months, and liabilities of UK£408.3m due beyond 12 months. On the other hand, it had cash of UK£166.0m and UK£61.4m worth of receivables due within a year. So it has liabilities totalling UK£490.5m 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£1.43b, 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, Pets at Home Group also has more cash than debt, so we're pretty confident it can manage its debt safely.

In addition to that, we're happy to report that Pets at Home Group has boosted its EBIT by 50%, thus reducing the spectre of future debt repayments. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Pets at Home Group 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. Happily for any shareholders, Pets at Home Group actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While Pets at Home Group does have more liabilities than liquid assets, it also has net cash of UK£69.1m. The cherry on top was that in converted 151% of that EBIT to free cash flow, bringing in UK£193m. So is Pets at Home Group's debt a risk? It doesn't seem so to us. 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. Case in point: We've spotted 1 warning sign for Pets at Home Group you should be aware of.

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.