We Think Dollar General (NYSE:DG) Is Taking Some Risk With Its Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 Dollar General Corporation (NYSE:DG) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

See our latest analysis for Dollar General

How Much Debt Does Dollar General Carry?

The chart below, which you can click on for greater detail, shows that Dollar General had US$7.00b in debt in February 2024; about the same as the year before. However, it does have US$537.3m in cash offsetting this, leading to net debt of about US$6.46b.

A Look At Dollar General's Liabilities

We can see from the most recent balance sheet that Dollar General had liabilities of US$6.73b falling due within a year, and liabilities of US$17.3b due beyond that. On the other hand, it had cash of US$537.3m and US$112.3m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$23.4b.

This is a mountain of leverage even relative to its gargantuan market capitalization of US$30.3b. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Dollar General's net debt of 2.0 times EBITDA suggests graceful use of debt. And the fact that its trailing twelve months of EBIT was 7.5 times its interest expenses harmonizes with that theme. Importantly, Dollar General's EBIT fell a jaw-dropping 26% in the last twelve months. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Dollar General can strengthen its balance sheet over time. 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. So it's worth checking how much of that EBIT is backed by free cash flow. In the last three years, Dollar General's free cash flow amounted to 32% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

We'd go so far as to say Dollar General's EBIT growth rate was disappointing. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Looking at the bigger picture, it seems clear to us that Dollar General's use of debt is creating risks for the company. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 4 warning signs with Dollar General , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.