Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from risk.” So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. Like many other companies Grocery Outlet Holding Corp. (NASDAQ: GO) uses debt. But the most important question is: what risk does this debt create?

When is debt dangerous?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. If things really go wrong, lenders can take over the business. While it’s not too common, we often see indebted companies continually diluting their shareholders because lenders are forcing them to raise capital at a ridiculous price. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we look at debt levels, we first consider both liquidity and debt levels.

Check out our latest review for Grocery Outlet Holding

How much debt does the grocery store have?

You can click on the graph below for historical figures, but it shows that Grocery Outlet Holding had a debt of US $ 449.7 million in April 2021, up from US $ 537.7 million a year earlier. However, it has $ 95.3 million in cash offsetting that, which leads to net debt of around $ 354.5 million.

NasdaqGS: GO Historical Debt to Equity June 8, 2021

A look at the liabilities of Grocery Outlet Holding

We can see from the most recent balance sheet that Grocery Outlet Holding had liabilities of US $ 197.1 million maturing within one year and liabilities of US $ 1.35 billion maturing within one year. of the. In return, he had $ 95.3 million in cash and $ 8.57 million in receivables due within 12 months. Its liabilities therefore total US $ 1.45 billion more than the combination of its cash and short-term receivables.

While that might sound like a lot, it’s not that bad since Grocery Outlet Holding has a market cap of $ 3.20 billion, so it could likely strengthen its balance sheet by raising capital if needed. However, it is always worth taking a close look at your ability to repay your debt.

In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). The advantage of this approach is that we take into account both the absolute amount of debt (with net debt versus EBITDA) and the actual interest charges associated with this debt (with its coverage rate). interests).

Grocery Outlet Holding’s net debt stands at a very reasonable level of 2.0 times its EBITDA, while its EBIT only covered its interest expense 6.3 times last year. While we’re not worried about these numbers, it’s worth noting that the company’s cost of debt does have a real impact. It should be noted that Grocery Outlet Holding’s EBIT has jumped like bamboo after the rain, gaining 75% in the past twelve months. This will make it easier to manage your debt. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the future profitability of the business will decide whether Grocery Outlet Holding 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.

Finally, while the IRS may love accounting profits, lenders only accept hard cash. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, Grocery Outlet Holding has recorded free cash flow of 35% of its EBIT, which is lower than expected. It’s not great when it comes to paying down debt.

Our point of view

When it comes to the balance sheet, the most notable bright spot for Grocery Outlet Holding was the fact that it appears to be able to grow its EBIT with confidence. But the other factors we noted above weren’t so encouraging. For example, its conversion from EBIT to free cash flow makes us a little nervous about its debt. When we consider all the elements mentioned above, it seems to us that Grocery Outlet Holding is managing its debt quite well. But beware: we believe debt levels are high enough to warrant continued monitoring. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks lie on the balance sheet – far from it. Concrete example: we have spotted 3 warning signs for Grocery Outlet Holding you must be aware.

If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash net growth stocks.

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