Dollar General (NYSE:DG) Has A Pretty Healthy Balance Sheet

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.' 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 Dollar General Corporation (NYSE:DG) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Dollar General

How Much Debt Does Dollar General Carry?

You can click the graphic below for the historical numbers, but it shows that as of April 2022 Dollar General had US$4.85b of debt, an increase on US$4.13b, over one year. However, because it has a cash reserve of US$335.6m, its net debt is less, at about US$4.51b.

A Look At Dollar General's Liabilities

According to the last reported balance sheet, Dollar General had liabilities of US$6.95b due within 12 months, and liabilities of US$14.0b due beyond 12 months. On the other hand, it had cash of US$335.6m and US$33.6m worth of receivables due within a year. So it has liabilities totalling US$20.6b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Dollar General is worth a massive US$52.4b, and thus could probably raise enough capital to shore up 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.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Dollar General's net debt is only 1.2 times its EBITDA. And its EBIT covers its interest expense a whopping 19.5 times over. So we're pretty relaxed about its super-conservative use of debt. On the other hand, Dollar General's EBIT dived 15%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Dollar General'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Dollar General recorded free cash flow worth 62% 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

When it comes to the balance sheet, the standout positive for Dollar General was the fact that it seems able to cover its interest expense with its EBIT confidently. However, our other observations weren't so heartening. In particular, EBIT growth rate gives us cold feet. Looking at all this data makes us feel a little cautious about Dollar General's debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Dollar General you should know about.

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.