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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about. 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 Peet Limited (ASX:PPC) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
See our latest analysis for Peet
How Much Debt Does Peet Carry?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 Peet had AU$257.1m of debt, an increase on AU$241.1m, over one year. However, because it has a cash reserve of AU$33.6m, its net debt is less, at about AU$223.5m.
How Healthy Is Peet's Balance Sheet?
We can see from the most recent balance sheet that Peet had liabilities of AU$92.3m falling due within a year, and liabilities of AU$269.8m due beyond that. Offsetting these obligations, it had cash of AU$33.6m as well as receivables valued at AU$25.2m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$303.3m.
While this might seem like a lot, it is not so bad since Peet has a market capitalization of AU$575.1m, 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.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.