Sprouts Farmers Market (NASDAQ:SFM) seems to be using debt quite wisely – Simply Wall St

David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. We note that Sprouts Farmers Market, Inc. (NASDAQ:SFM) has debt on its balance sheet. But the real question is whether this debt makes the business risky.

When is debt dangerous?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.

Check out our latest analysis for Sprouts Farmers Market

What is Sprouts Farmers Market net debt?

As you can see below, Sprouts Farmers Market had $250.0 million in debt as of October 2022, roughly the same as the previous year. You can click on the graph for more details. However, his balance sheet shows that he holds $316.7 million in cash, so he actually has $66.7 million in net cash.

A Look at Sprouts Farmers Market Responsibilities

The latest balance sheet data shows that Sprouts Farmers Market had liabilities of US$525.1 million due within one year, and liabilities of US$1.45 billion falling due thereafter. On the other hand, it had liquidities of 316.7 million dollars and 11.5 million dollars of receivables at less than one year. Thus, its liabilities total $1.65 billion more than the combination of its cash and short-term receivables.

This shortfall isn’t that bad, as Sprouts Farmers Market is worth US$3.46 billion and could therefore likely raise enough capital to shore up its balance sheet, should the need arise. However, it is always worth taking a close look at its ability to repay debt. Despite its notable liabilities, Sprouts Farmers Market has clean cash, so it’s fair to say it doesn’t have heavy debt!

In contrast, Sprouts Farmers Market has seen its EBIT fall by 6.1% over the last twelve months. If earnings continue to decline at this rate, the company could find it increasingly difficult to manage its debt. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Sprouts Farmers Market can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. Sprouts Farmers Market may have net cash on the balance sheet, but it’s always interesting to see how well the business converts its earnings before interest and taxes (EBIT) into free cash flow, as this will influence both its need and its ability to manage debt. Over the past three years, Sprouts Farmers Market has produced strong free cash flow equivalent to 80% of its EBIT, about what we expected. This free cash flow puts the company in a good position to repay its debt, should it arise.

Summary

Although Sprouts Farmers Market’s balance sheet is not particularly strong, due to total liabilities, it is clearly positive to see that it has a net cash position of $66.7 million. The icing on the cake was converting 80% of that EBIT into free cash flow, bringing in $262 million. We therefore have no problem with the use of debt by Sprouts Farmers Market. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. To this end, you should be aware of the 1 warning sign we spotted with Sprouts Farmers Market.

If, after all that, you’re more interested in a fast-growing company with a strong balance sheet, check out our list of cash-flowing growth stocks without further ado.

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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.