Dis-Chem Pharmacies (JSE:DCP) 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 note that Dis-Chem Pharmacies Limited (JSE:DCP) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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 examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Dis-Chem Pharmacies

How Much Debt Does Dis-Chem Pharmacies Carry?

As you can see below, at the end of February 2022, Dis-Chem Pharmacies had R1.30b of debt, up from R1.17b a year ago. Click the image for more detail. On the flip side, it has R705.9m in cash leading to net debt of about R597.2m.

How Healthy Is Dis-Chem Pharmacies' Balance Sheet?

The latest balance sheet data shows that Dis-Chem Pharmacies had liabilities of R7.51b due within a year, and liabilities of R3.18b falling due after that. Offsetting these obligations, it had cash of R705.9m as well as receivables valued at R2.39b due within 12 months. So it has liabilities totalling R7.59b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Dis-Chem Pharmacies is worth R29.4b, 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.

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).

Looking at its net debt to EBITDA of 0.25 and interest cover of 4.9 times, it seems to us that Dis-Chem Pharmacies is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. If Dis-Chem Pharmacies can keep growing EBIT at last year's rate of 19% over the last year, then it will find its debt load easier to manage. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Dis-Chem Pharmacies'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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Dis-Chem Pharmacies generated free cash flow amounting to a very robust 82% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Dis-Chem Pharmacies's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its net debt to EBITDA also supports that impression! Zooming out, Dis-Chem Pharmacies seems to use debt quite reasonably; and that gets the nod from us. While debt does bring risk, when used wisely it can also bring a higher return on equity. We'd be motivated to research the stock further if we found out that Dis-Chem Pharmacies insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.

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.