Is J Sainsbury (LON:SBRY) 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.' 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. As with many other companies J Sainsbury plc (LON:SBRY) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for J Sainsbury

What Is J Sainsbury's Net Debt?

You can click the graphic below for the historical numbers, but it shows that J Sainsbury had UK£730.0m of debt in March 2023, down from UK£793.0m, one year before. But it also has UK£1.32b in cash to offset that, meaning it has UK£589.0m net cash.

A Look At J Sainsbury's Liabilities

According to the last reported balance sheet, J Sainsbury had liabilities of UK£11.6b due within 12 months, and liabilities of UK£7.29b due beyond 12 months. On the other hand, it had cash of UK£1.32b and UK£453.0m worth of receivables due within a year. So it has liabilities totalling UK£17.1b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the UK£5.99b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, J Sainsbury would probably need a major re-capitalization if its creditors were to demand repayment. Given that J Sainsbury has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.

Sadly, J Sainsbury's EBIT actually dropped 3.1% in the last year. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine J Sainsbury'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. J Sainsbury 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. Over the last three years, J Sainsbury actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While J Sainsbury does have more liabilities than liquid assets, it also has net cash of UK£589.0m. The cherry on top was that in converted 125% of that EBIT to free cash flow, bringing in UK£1.4b. So while J Sainsbury does not have a great balance sheet, it's certainly not too bad. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 3 warning signs for J Sainsbury that you should be aware of before investing here.

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.

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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.