David Iben put it well when he said: “Volatility is not a risk that is close to our hearts. What matters to us is to avoid the permanent loss of capital. ‘ So it can be obvious that you need to consider debt, when you think about how risky a given stock is because too much debt can sink a business. Like many other companies Coles Group Limited (ASX: COL) uses debt. But should shareholders be concerned about its use of debt?
Why Does Debt Bring Risk?
Generally speaking, debt only becomes a real problem when a company cannot repay it easily, either by raising capital or with its own cash flow. If things really go wrong, lenders can take over the business. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. That said, the most common situation is where a business manages its debt reasonably well – and to its own advantage. When we think of a business’s use of debt, we first look at cash flow and debt together.
Discover our latest analysis for Coles Group
What is Coles Group’s net debt?
As you can see below, Coles Group was in debt of A $ 1.14 billion in January 2021, up from A $ 1.36 billion the year before. However, his balance sheet shows that he has A $ 1.18 billion in cash, so he actually has net cash of A $ 38.0 million.
How healthy is Coles Group’s balance sheet?
Zooming in on the latest balance sheet data, we can see that Coles Group had A $ 6.26 billion in liabilities due within 12 months and A $ 9.90 billion in liabilities beyond. In compensation for these obligations, it had cash of A $ 1.18 billion as well as receivables valued at A $ 415.0 million maturing within 12 months. It therefore has liabilities totaling AUD 14.6 billion more than its cash and short-term receivables combined.
That’s a mountain of leverage even compared to its gargantuan market cap of A $ 22.3 billion. If its lenders asked it to consolidate the balance sheet, shareholders would likely face severe dilution. While it has some liabilities to note, Coles Group also has more cash than debt, so we’re pretty confident it can handle its debt safely.
It should be noted that Coles Group EBIT has soared like bamboo after the rain, gaining 30% in the last twelve months. This will make it easier to manage your debt. The balance sheet is clearly the area you need to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Coles Group can strengthen its balance sheet over time. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
Finally, a business needs free cash flow to pay off debts; accounting profits are not enough. Coles Group may have net cash on the balance sheet, but it is always interesting to consider the extent to which the company converts its earnings before interest and taxes (EBIT) into free cash flow, as this will influence both its need and its cost. ability to manage debt. Over the past three years, Coles Group has recorded free cash flow totaling 99% of its EBIT, which is higher than what we normally expected. This positions it well to repay debt if it is desirable.
Although Coles Group’s balance sheet is not particularly strong, due to total liabilities it is clearly positive to see that it has net cash of AUD 38.0 million. And he impressed us with free cash flow of A $ 2.2 billion, or 99% of his EBIT. We therefore have no problem with the use of debt by Coles Group. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks lie on the balance sheet – far from it. Concrete example: we have spotted 2 warning signs for Coles Group you must be aware.
If you are interested in investing in companies that can generate profits without the burden of debt, check out this page free list of growing companies that have net cash on the balance sheet.
This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in the mentioned stocks.
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