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David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 Sprouts Farmers Market, Inc. (NASDAQ:SFM) makes use of debt. But the real question is whether this debt is making the company risky.
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Sprouts Farmers Market Carry?
The image below, which you can click on for greater detail, shows that Sprouts Farmers Market had debt of US$257.3m at the end of October 2021, a reduction from US$288.2m over a year. However, it does have US$260.2m in cash offsetting this, leading to net cash of US$2.94m.
How Healthy Is Sprouts Farmers Market's Balance Sheet?
According to the last reported balance sheet, Sprouts Farmers Market had liabilities of US$507.2m due within 12 months, and liabilities of US$1.45b due beyond 12 months. On the other hand, it had cash of US$260.2m and US$19.5m worth of receivables due within a year. So it has liabilities totalling US$1.68b more than its cash and near-term receivables, combined.
This is a mountain of leverage relative to its market capitalization of US$2.76b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. While it does have liabilities worth noting, Sprouts Farmers Market also has more cash than debt, so we're pretty confident it can manage its debt safely.
The good news is that Sprouts Farmers Market has increased its EBIT by 7.2% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Sprouts Farmers Market's ability to maintain a healthy balance sheet going forward. 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. While Sprouts Farmers Market has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Sprouts Farmers Market generated free cash flow amounting to a very robust 85% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
Although Sprouts Farmers Market's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$2.94m. And it impressed us with free cash flow of US$284m, being 85% of its EBIT. So we don't have any problem with Sprouts Farmers Market's use of debt. We'd be motivated to research the stock further if we found out that Sprouts Farmers Market insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.
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.
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.
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