We Think Pets at Home Group (LON:PETS) Can Stay On Top Of Its Debt

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.' 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. 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?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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?

The image below, which you can click on for greater detail, shows that Pets at Home Group had debt of UK£45.1m at the end of October 2023, a reduction from UK£97.4m over a year. However, its balance sheet shows it holds UK£60.4m in cash, so it actually has UK£15.3m net cash.

A Look At Pets at Home Group's Liabilities

According to the last reported balance sheet, Pets at Home Group had liabilities of UK£366.4m due within 12 months, and liabilities of UK£371.4m due beyond 12 months. Offsetting these obligations, it had cash of UK£60.4m as well as receivables valued at UK£59.6m due within 12 months. So its liabilities total UK£617.8m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because Pets at Home Group is worth UK£1.43b, 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.

On the other hand, Pets at Home Group saw its EBIT drop by 5.0% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder 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 Pets at Home Group 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.

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. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

Although Pets at Home Group'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£15.3m. And it impressed us with free cash flow of UK£154m, being 129% of its EBIT. So we are not troubled with Pets at Home Group'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. For example - Pets at Home Group has 2 warning signs we think you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.