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.' 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. We can see that Dollar General Corporation (NYSE:DG) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Dollar General

What Is Dollar General's Net Debt?

The image below, which you can click on for greater detail, shows that at October 2022 Dollar General had debt of US$5.99b, up from US$4.13b in one year. However, because it has a cash reserve of US$362.7m, its net debt is less, at about US$5.62b.

How Strong Is Dollar General's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Dollar General had liabilities of US$6.50b due within 12 months and liabilities of US$16.4b due beyond that. On the other hand, it had cash of US$362.7m and US$188.1m worth of receivables due within a year. So it has liabilities totalling US$22.4b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Dollar General is worth a massive US$51.9b, 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.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Dollar General's net debt is only 1.4 times its EBITDA. And its EBIT covers its interest expense a whopping 18.3 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On the other hand, Dollar General saw its EBIT drop by 3.2% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Dollar General produced sturdy free cash flow equating to 52% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

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. For example, its EBIT growth rate makes us a little nervous about its debt. 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. For example, we've discovered 1 warning sign for Dollar General that you should be aware of before investing here.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.