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. As with many other companies Natural Grocers by Vitamin Cottage, Inc. (NYSE:NGVC) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Natural Grocers by Vitamin Cottage's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Natural Grocers by Vitamin Cottage had US$15.1m of debt, an increase on US$11.7m, over one year. On the flip side, it has US$11.0m in cash leading to net debt of about US$4.12m.

A Look At Natural Grocers by Vitamin Cottage's Liabilities

We can see from the most recent balance sheet that Natural Grocers by Vitamin Cottage had liabilities of US$159.9m falling due within a year, and liabilities of US$336.7m due beyond that. On the other hand, it had cash of US$11.0m and US$8.74m worth of receivables due within a year. So it has liabilities totalling US$476.9m more than its cash and near-term receivables, combined.

This is a mountain of leverage relative to its market capitalization of US$533.3m. This suggests shareholders would be heavily diluted if the company needed to shore up its balance sheet in a hurry. But either way, Natural Grocers by Vitamin Cottage has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Natural Grocers by Vitamin Cottage has very little debt (net of cash), and boasts a debt to EBITDA ratio of 0.058 and EBIT of 10.6 times the interest expense. Indeed relative to its earnings its debt load seems light as a feather. On top of that, Natural Grocers by Vitamin Cottage grew its EBIT by 43% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Natural Grocers by Vitamin Cottage's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the most recent three years, Natural Grocers by Vitamin Cottage recorded free cash flow worth 63% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.

Our View

Natural Grocers by Vitamin Cottage's EBIT growth rate suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But, on a more sombre note, we are a little concerned by its level of total liabilities. All these things considered, it appears that Natural Grocers by Vitamin Cottage can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Natural Grocers by Vitamin Cottage , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.

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