Yahoo Finance Is Berkeley Group Holdings (LON:BKG) A Risky Investment?
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 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 can see that The Berkeley Group Holdings plc (LON:BKG) does use debt in its business. But the more important question is: how much risk is that debt creating?
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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.
See our latest analysis for Berkeley Group Holdings
What Is Berkeley Group Holdings's Net Debt?
The chart below, which you can click on for greater detail, shows that Berkeley Group Holdings had UK£300.0m in debt in October 2019; about the same as the year before. But on the other hand it also has UK£1.36b in cash, leading to a UK£1.06b net cash position.
How Strong Is Berkeley Group Holdings's Balance Sheet?
The latest balance sheet data shows that Berkeley Group Holdings had liabilities of UK£1.64b due within a year, and liabilities of UK£418.1m falling due after that. Offsetting this, it had UK£1.36b in cash and UK£98.6m in receivables that were due within 12 months. So it has liabilities totalling UK£598.4m more than its cash and near-term receivables, combined.
Since publicly traded Berkeley Group Holdings shares are worth a total of UK£5.26b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Berkeley Group Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.
But the bad news is that Berkeley Group Holdings has seen its EBIT plunge 12% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Berkeley Group Holdings can strengthen its balance sheet over time. 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. Berkeley Group Holdings 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. During the last three years, Berkeley Group Holdings produced sturdy free cash flow equating to 72% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
Summing up
Although Berkeley Group Holdings'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£1.06b. The cherry on top was that in converted 72% of that EBIT to free cash flow, bringing in UK£257m. So we don't have any problem with Berkeley Group Holdings's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Be aware that Berkeley Group Holdings is showing 2 warning signs in our investment analysis , you should know about...
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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