Is Karooooo (NASDAQ:KARO) A Risky Investment?

Warren Buffett famously said, '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. We can see that Karooooo Ltd. (NASDAQ:KARO) 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 assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Karooooo

What Is Karooooo's Debt?

The image below, which you can click on for greater detail, shows that Karooooo had debt of R51.6m at the end of November 2023, a reduction from R68.5m over a year. However, it does have R782.0m in cash offsetting this, leading to net cash of R730.4m.

A Look At Karooooo's Liabilities

We can see from the most recent balance sheet that Karooooo had liabilities of R979.7m falling due within a year, and liabilities of R355.2m due beyond that. On the other hand, it had cash of R782.0m and R528.2m worth of receivables due within a year. So these liquid assets roughly match the total liabilities.

This state of affairs indicates that Karooooo's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the R15.1b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Karooooo boasts net cash, so it's fair to say it does not have a heavy debt load!

Also positive, Karooooo grew its EBIT by 21% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Karooooo 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. Karooooo 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. During the last three years, Karooooo produced sturdy free cash flow equating to 62% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

We could understand if investors are concerned about Karooooo's liabilities, but we can be reassured by the fact it has has net cash of R730.4m. And it impressed us with its EBIT growth of 21% over the last year. So we don't think Karooooo's use of debt is risky. 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. Be aware that Karooooo is showing 1 warning sign in our investment analysis , you should know about...

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.

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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.