PriceSmart (NASDAQ:PSMT) Seems To Use Debt Quite Sensibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We can see that PriceSmart, Inc. (NASDAQ:PSMT) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. 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 PriceSmart

What Is PriceSmart's Net Debt?

The image below, which you can click on for greater detail, shows that PriceSmart had debt of US$148.0m at the end of November 2023, a reduction from US$162.9m over a year. But it also has US$266.0m in cash to offset that, meaning it has US$118.0m net cash.

How Healthy Is PriceSmart's Balance Sheet?

According to the last reported balance sheet, PriceSmart had liabilities of US$705.2m due within 12 months, and liabilities of US$241.8m due beyond 12 months. Offsetting these obligations, it had cash of US$266.0m as well as receivables valued at US$40.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$640.1m.

While this might seem like a lot, it is not so bad since PriceSmart has a market capitalization of US$2.32b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, PriceSmart boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that PriceSmart grew its EBIT at 17% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if PriceSmart 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. PriceSmart 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. In the last three years, PriceSmart's free cash flow amounted to 32% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While PriceSmart does have more liabilities than liquid assets, it also has net cash of US$118.0m. And we liked the look of last year's 17% year-on-year EBIT growth. So we are not troubled with PriceSmart's debt use. 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.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.