We Think Shoprite Holdings (JSE:SHP) Can Stay On Top Of Its Debt

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 Shoprite Holdings Ltd (JSE:SHP) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for Shoprite Holdings

What Is Shoprite Holdings's Net Debt?

As you can see below, at the end of July 2022, Shoprite Holdings had R10.5b of debt, up from R6.50b a year ago. Click the image for more detail. But it also has R11.1b in cash to offset that, meaning it has R598.0m net cash.

How Strong Is Shoprite Holdings' Balance Sheet?

According to the last reported balance sheet, Shoprite Holdings had liabilities of R32.5b due within 12 months, and liabilities of R33.3b due beyond 12 months. Offsetting this, it had R11.1b in cash and R6.27b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by R48.5b.

While this might seem like a lot, it is not so bad since Shoprite Holdings has a market capitalization of R122.6b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, Shoprite Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Sadly, Shoprite Holdings's EBIT actually dropped 5.3% in the last year. If that earnings trend continues then its debt load will grow heavy like the heart of a polar bear watching its sole cub. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Shoprite Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Shoprite Holdings 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. During the last three years, Shoprite Holdings produced sturdy free cash flow equating to 80% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

While Shoprite Holdings does have more liabilities than liquid assets, it also has net cash of R598.0m. And it impressed us with free cash flow of R4.5b, being 80% of its EBIT. So we don't have any problem with Shoprite Holdings's use of debt. We'd be motivated to research the stock further if we found out that Shoprite Holdings 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.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.