These 4 Measures Indicate That Karooooo (NASDAQ:KARO) Is Using Debt Safely

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 Karooooo Ltd. (NASDAQ:KARO) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Karooooo

How Much Debt Does Karooooo Carry?

As you can see below, at the end of August 2024, Karooooo had R323.8m of debt, up from R54.6m a year ago. Click the image for more detail. However, it does have R706.8m in cash offsetting this, leading to net cash of R383.0m.

How Healthy Is Karooooo's Balance Sheet?

We can see from the most recent balance sheet that Karooooo had liabilities of R1.06b falling due within a year, and liabilities of R588.5m due beyond that. Offsetting these obligations, it had cash of R706.8m as well as receivables valued at R530.8m due within 12 months. So its liabilities total R407.6m more than the combination of its cash and short-term receivables.

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 while it's hard to imagine that the R27.0b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Karooooo also has more cash than debt, so we're pretty confident it can manage its debt safely.

Also positive, Karooooo grew its EBIT by 28% in the last year, and that should make it easier to pay down debt, going forward. 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 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Karooooo has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent three years, Karooooo recorded free cash flow of 49% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

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 R383.0m. And we liked the look of last year's 28% year-on-year EBIT growth. So is Karooooo's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Karooooo .

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.