Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 note that BJ's Wholesale Club Holdings, Inc. (NYSE:BJ) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
Check out our latest analysis for BJ's Wholesale Club Holdings
You can click the graphic below for the historical numbers, but it shows that BJ's Wholesale Club Holdings had US$615.6m of debt in August 2024, down from US$859.1m, one year before. On the flip side, it has US$38.1m in cash leading to net debt of about US$577.5m.
The latest balance sheet data shows that BJ's Wholesale Club Holdings had liabilities of US$2.52b due within a year, and liabilities of US$2.75b falling due after that. Offsetting this, it had US$38.1m in cash and US$248.5m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$4.99b.
While this might seem like a lot, it is not so bad since BJ's Wholesale Club Holdings has a huge market capitalization of US$11.4b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
BJ's Wholesale Club Holdings has a low net debt to EBITDA ratio of only 0.55. And its EBIT covers its interest expense a whopping 13.4 times over. So we're pretty relaxed about its super-conservative use of debt. The good news is that BJ's Wholesale Club Holdings has increased its EBIT by 2.3% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if BJ's Wholesale Club 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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, BJ's Wholesale Club Holdings's free cash flow amounted to 41% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
On our analysis BJ's Wholesale Club Holdings's interest cover should signal that it won't have too much trouble with its debt. However, our other observations weren't so heartening. For example, its level of total liabilities makes us a little nervous about its debt. Considering this range of data points, we think BJ's Wholesale Club Holdings is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 1 warning sign for BJ's Wholesale Club Holdings that you should be aware of before investing here.
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.