Does Pennon Group (LON: PNN) have a healthy balance sheet?

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Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital”. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. Above all, Pennon Group Plc (LON: PNN) is in debt. But the real question is whether this debt makes the business risky.

When is debt dangerous?

Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. If things really go wrong, lenders can take over the business. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. When we look at debt levels, we first look at cash and debt levels together.

See our latest analysis for Pennon Group

What is the debt of Pennon Group?

As you can see below, Pennon Group was in debt of £ 1.44bn in March 2021, up from £ 2.31bn the year before. But on the other hand, he also has £ 2.67bn in cash, which leads to a net cash position of £ 1.23bn.

LSE: PNN History of debt on equity September 4, 2021

How strong is Pennon Group’s balance sheet?

Zooming in on the latest balance sheet data, we can see that Pennon Group had liabilities of £ 223.8million due within 12 months and liabilities of £ 3.21 billion beyond. On the other hand, he had £ 2.67 billion in cash and £ 208.5 million in receivables due within one year. Its liabilities therefore total £ 558.2million more than the combination of its cash and short-term receivables.

Given that Pennon Group has a market capitalization of £ 3.50 billion, it is hard to believe that these liabilities pose a significant threat. But there are enough liabilities that we would certainly recommend that shareholders continue to monitor the balance sheet going forward. While it has some liabilities to note, Pennon Group also has more cash than debt, so we’re pretty confident it can handle its debt safely.

It is important to note that Pennon Group’s EBIT has fallen 20% over the past twelve months. If this decline continues, it will be more difficult to pay off the debt than to sell foie gras at a vegan convention. The balance sheet is clearly the area you need to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Pennon Group can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.

But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. Pennon Group may have net cash on the balance sheet, but it is always interesting to consider the extent to which the company converts its earnings before interest and taxes (EBIT) into free cash flow, as this will influence both its need and its ability to manage debt. Considering the past three years, Pennon Group has indeed recorded a cash outflow, overall. Debt is much riskier for companies with unreliable free cash flow, so shareholders should hope that past spending will produce free cash flow in the future.

In summary

While Pennon Group’s balance sheet is not particularly strong, due to total liabilities it is clearly positive that it has net cash of £ 1.23 billion. So while we see areas for improvement, we are not overly worried about Pennon Group’s balance sheet. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist off the balance sheet. To this end, you should inquire about the 3 warning signs we spotted with Pennon Group (including 1 that should not be overlooked).

At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.

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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
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