Here's Why Victory Supermarket Chain (TLV:VCTR) Has A Meaningful Debt Burden

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Victory Supermarket Chain Ltd (TLV:VCTR) does carry debt. But is this debt a concern to shareholders?

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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Victory Supermarket Chain

What Is Victory Supermarket Chain's Debt?

The image below, which you can click on for greater detail, shows that Victory Supermarket Chain had debt of ₪72.7m at the end of June 2023, a reduction from ₪103.9m over a year. However, it does have ₪102.8m in cash offsetting this, leading to net cash of ₪30.1m.

A Look At Victory Supermarket Chain's Liabilities

The latest balance sheet data shows that Victory Supermarket Chain had liabilities of ₪540.1m due within a year, and liabilities of ₪1.03b falling due after that. Offsetting this, it had ₪102.8m in cash and ₪210.0m in receivables that were due within 12 months. So its liabilities total ₪1.25b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the ₪463.8m company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. At the end of the day, Victory Supermarket Chain would probably need a major re-capitalization if its creditors were to demand repayment. Given that Victory Supermarket Chain 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, Victory Supermarket Chain's EBIT actually dropped 6.1% 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. When analysing debt levels, the balance sheet is the obvious place to start. But it is Victory Supermarket Chain'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 Victory Supermarket Chain 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. Happily for any shareholders, Victory Supermarket Chain actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

Although Victory Supermarket Chain's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of ₪30.1m. And it impressed us with free cash flow of ₪120m, being 148% of its EBIT. Despite the cash, we do find Victory Supermarket Chain'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. To that end, you should be aware of the 1 warning sign we've spotted with Victory Supermarket Chain .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.