Stock Analysis

Sprouts Farmers Market (NASDAQ:SFM) Seems To Use Debt Quite Sensibly

NasdaqGS:SFM
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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 Sprouts Farmers Market, Inc. (NASDAQ:SFM) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Sprouts Farmers Market

How Much Debt Does Sprouts Farmers Market Carry?

The chart below, which you can click on for greater detail, shows that Sprouts Farmers Market had US$251.8m in debt in April 2022; about the same as the year before. But on the other hand it also has US$324.3m in cash, leading to a US$72.5m net cash position.

debt-equity-history-analysis
NasdaqGS:SFM Debt to Equity History July 17th 2022

How Strong Is Sprouts Farmers Market's Balance Sheet?

We can see from the most recent balance sheet that Sprouts Farmers Market had liabilities of US$523.7m falling due within a year, and liabilities of US$1.46b due beyond that. On the other hand, it had cash of US$324.3m and US$13.7m worth of receivables due within a year. So it has liabilities totalling US$1.65b more than its cash and near-term receivables, combined.

Sprouts Farmers Market has a market capitalization of US$3.01b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Sprouts Farmers Market boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, Sprouts Farmers Market saw its EBIT drop by 9.6% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. The balance sheet is clearly the area to focus on when you are analysing debt. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Sprouts Farmers Market 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. Over the last three years, Sprouts Farmers Market recorded free cash flow worth a fulsome 86% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing up

Although Sprouts Farmers Market'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$72.5m. And it impressed us with free cash flow of US$299m, being 86% of its EBIT. So we are not troubled with Sprouts Farmers Market's debt use. 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. For example - Sprouts Farmers Market has 1 warning sign we think you should be aware of.

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.

Valuation is complex, but we're helping make it simple.

Find out whether Sprouts Farmers Market is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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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.