Is PetIQ (NASDAQ:PETQ) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that PetIQ, Inc. (NASDAQ:PETQ) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for PetIQ

How Much Debt Does PetIQ Carry?

The chart below, which you can click on for greater detail, shows that PetIQ had US$450.3m in debt in December 2021; about the same as the year before. However, it also had US$79.4m in cash, and so its net debt is US$370.9m.

How Strong Is PetIQ's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that PetIQ had liabilities of US$98.1m due within 12 months and liabilities of US$466.3m due beyond that. Offsetting this, it had US$79.4m in cash and US$113.9m in receivables that were due within 12 months. So it has liabilities totalling US$371.0m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of US$519.6m, so it does suggest shareholders should keep an eye on PetIQ's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

PetIQ shareholders face the double whammy of a high net debt to EBITDA ratio (6.5), and fairly weak interest coverage, since EBIT is just 0.81 times the interest expense. The debt burden here is substantial. On a slightly more positive note, PetIQ grew its EBIT at 17% over the last year, further increasing its ability to manage debt. 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 PetIQ 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, PetIQ saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, PetIQ's interest cover left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at growing its EBIT; that's encouraging. It's also worth noting that PetIQ is in the Healthcare industry, which is often considered to be quite defensive. Overall, we think it's fair to say that PetIQ has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for PetIQ you should be aware of, and 1 of them is a bit concerning.

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.