PriceSmart (NASDAQ:PSMT) Has A Pretty Healthy Balance Sheet

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.' 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. We can see that PriceSmart, Inc. (NASDAQ:PSMT) does use debt in its business. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

View our latest analysis for PriceSmart

What Is PriceSmart's Net Debt?

As you can see below, PriceSmart had US$156.0m of debt, at May 2023, which is about the same as the year before. You can click the chart for greater detail. However, it does have US$335.3m in cash offsetting this, leading to net cash of US$179.3m.

How Healthy Is PriceSmart's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that PriceSmart had liabilities of US$587.3m due within 12 months and liabilities of US$256.4m due beyond that. On the other hand, it had cash of US$335.3m and US$37.1m worth of receivables due within a year. So it has liabilities totalling US$471.2m more than its cash and near-term receivables, combined.

PriceSmart has a market capitalization of US$2.22b, so it could very likely raise cash to ameliorate 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, PriceSmart boasts net cash, so it's fair to say it does not have a heavy debt load!

Another good sign is that PriceSmart has been able to increase its EBIT by 23% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine PriceSmart's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While PriceSmart 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. In the last three years, PriceSmart's free cash flow amounted to 34% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

Although PriceSmart'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$179.3m. And we liked the look of last year's 23% year-on-year EBIT growth. So we don't have any problem with PriceSmart's use of debt. We'd be motivated to research the stock further if we found out that PriceSmart insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.

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.