Is J Sainsbury (LON:SBRY) A Risky Investment?

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies J Sainsbury plc (LON:SBRY) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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.

Check out 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 as of September 2023 J Sainsbury had UK£1.32b of debt, an increase on UK£795.0m, over one year. But on the other hand it also has UK£2.07b in cash, leading to a UK£752.0m net cash position.

How Healthy Is J Sainsbury's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that J Sainsbury had liabilities of UK£11.6b due within 12 months and liabilities of UK£7.35b due beyond that. On the other hand, it had cash of UK£2.07b and UK£669.0m worth of receivables due within a year. So its liabilities total UK£16.2b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the UK£6.34b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. 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.

The bad news is that J Sainsbury saw its EBIT decline by 12% over the last year. If earnings continue to decline at that rate then handling the debt will be more difficult than taking three children under 5 to a fancy pants restaurant. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if J Sainsbury can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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. During the last three years, J Sainsbury generated free cash flow amounting to a very robust 91% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing Up

Although J Sainsbury's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of UK£752.0m. The cherry on top was that in converted 91% of that EBIT to free cash flow, bringing in UK£341m. Despite the cash, we do find J Sainsbury's level of total liabilities concerning, so we're not particularly comfortable with the stock. 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. Be aware that J Sainsbury is showing 3 warning signs in our investment analysis , you should know about...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.