Stock Analysis

Is BJ's Wholesale Club Holdings (NYSE:BJ) Using Too Much Debt?

NYSE:BJ
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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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that BJ's Wholesale Club Holdings, Inc. (NYSE:BJ) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for BJ's Wholesale Club Holdings

What Is BJ's Wholesale Club Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at July 2022 BJ's Wholesale Club Holdings had debt of US$1.05b, up from US$762.3m in one year. However, because it has a cash reserve of US$163.7m, its net debt is less, at about US$885.7m.

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NYSE:BJ Debt to Equity History October 13th 2022

How Strong Is BJ's Wholesale Club Holdings' Balance Sheet?

Zooming in on the latest balance sheet data, we can see that BJ's Wholesale Club Holdings had liabilities of US$2.48b due within 12 months and liabilities of US$3.05b due beyond that. Offsetting this, it had US$163.7m in cash and US$204.5m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$5.17b.

BJ's Wholesale Club Holdings has a market capitalization of US$9.67b, 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.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

BJ's Wholesale Club Holdings has a low net debt to EBITDA ratio of only 1.0. And its EBIT easily covers its interest expense, being 16.6 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The good news is that BJ's Wholesale Club Holdings has increased its EBIT by 8.3% 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 ultimately the future profitability of the business will decide if BJ's Wholesale Club Holdings 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.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the most recent three years, BJ's Wholesale Club Holdings recorded free cash flow worth 78% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

BJ's Wholesale Club Holdings's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its level of total liabilities does undermine this impression a bit. When we consider the range of factors above, it looks like BJ's Wholesale Club Holdings is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. 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. To that end, you should be aware of the 1 warning sign we've spotted with BJ's Wholesale Club Holdings .

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.

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

Find out whether BJ's Wholesale Club Holdings 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.