Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk'. 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. Importantly, Village Super Market, Inc. (NASDAQ:VLGE.A) does carry debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 examine debt levels, we first consider both cash and debt levels, together.
What Is Village Super Market's Net Debt?
As you can see below, Village Super Market had US$7.04m of debt at October 2019, down from US$7.83m a year prior. However, it does have US$77.9m in cash offsetting this, leading to net cash of US$70.9m.
How Healthy Is Village Super Market's Balance Sheet?
According to the last reported balance sheet, Village Super Market had liabilities of US$120.4m due within 12 months, and liabilities of US$138.8m due beyond 12 months. On the other hand, it had cash of US$77.9m and US$16.4m worth of receivables due within a year. So it has liabilities totalling US$165.0m more than its cash and near-term receivables, combined.
This deficit isn't so bad because Village Super Market is worth US$324.2m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. Despite its noteworthy liabilities, Village Super Market boasts net cash, so it's fair to say it does not have a heavy debt load!
In fact Village Super Market's saving grace is its low debt levels, because its EBIT has tanked 21% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is Village Super Market's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Village Super 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, Village Super Market produced sturdy free cash flow equating to 67% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Although Village Super 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$70.9m. The cherry on top was that in converted 67% of that EBIT to free cash flow, bringing in US$11m. So we don't have any problem with Village Super Market'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. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Village Super Market (at least 1 which is significant) , and understanding them should be part of your investment process.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
If you spot an error that warrants correction, please contact the editor at email@example.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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