Stock Analysis

Here's Why Sprouts Farmers Market (NASDAQ:SFM) Can Manage Its Debt Responsibly

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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.' 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 Sprouts Farmers Market, Inc. (NASDAQ:SFM) 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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Sprouts Farmers Market

What Is Sprouts Farmers Market's Net Debt?

The image below, which you can click on for greater detail, shows that Sprouts Farmers Market had debt of US$225.0m at the end of April 2023, a reduction from US$251.8m over a year. However, its balance sheet shows it holds US$294.9m in cash, so it actually has US$69.9m net cash.

NasdaqGS:SFM Debt to Equity History May 27th 2023

How Strong Is Sprouts Farmers Market's Balance Sheet?

The latest balance sheet data shows that Sprouts Farmers Market had liabilities of US$515.1m due within a year, and liabilities of US$1.60b falling due after that. Offsetting these obligations, it had cash of US$294.9m as well as receivables valued at US$12.4m due within 12 months. So its liabilities total US$1.81b more than the combination of its cash and short-term receivables.

Sprouts Farmers Market has a market capitalization of US$3.70b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. Despite its noteworthy liabilities, Sprouts Farmers Market boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that Sprouts Farmers Market has increased its EBIT by 8.9% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Sprouts Farmers Market'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 Sprouts Farmers Market 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. Over the most recent three years, Sprouts Farmers Market recorded free cash flow worth 70% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While Sprouts Farmers Market does have more liabilities than liquid assets, it also has net cash of US$69.9m. The cherry on top was that in converted 70% of that EBIT to free cash flow, bringing in US$254m. So we are not troubled with Sprouts Farmers Market's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 1 warning sign for Sprouts Farmers Market you should be aware of.

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.