In the competitive world of retail, strategic financial management is key to maintaining a strong market position.
Coles Group Ltd (ASX: COL), one of Australia's leading supermarket chains, has navigated this landscape with operational strategies and financial manoeuvres.
However, in today's financial landscape, characterised by rising interest rates, the importance of thorough balance sheet analysis has never been greater. Investors are increasingly focusing on the debt levels of companies to assess their financial health and long-term viability. This is because high interest rates can significantly impact a company's cost of borrowing, cash flow, and overall financial stability.
With this background, I delve into Coles' financial health, examine its debt profile, and explore the potential implications in this article.
Debt-to-equity ratio
The debt-to-equity ratio is a way to see how much a company is borrowing compared to how much it owns. Think of it like this:
- Debt is money the company has borrowed and needs to pay back.
- Equity is money that the company's owners have put into the business.
The debt-to-equity ratio compares these two amounts. It shows how much debt the company has for every dollar of equity.
As at 31 December 2023, Coles has a total debt of $9.4 billion, including lease liabilities of $7.7 billion. Adjusting for its cash and short-term investment balance of $1.1 billion, its net debt reduces to $8.3 billion. The retailer managed to reduce its net debt levels gradually over time, from $9.4 billion in June 2020 to $7.7 billion in December 2023.
Net debt excluding lease liabilities was $1.2 billion, up $133 million from June 2023 due to increased capital expenditures.
During this period, Coles' equity has risen from $2.6 billion to $3.5 billion, indicating its debt-to-equity ratios have improved from 3.6x to 2.4x. In other words, Coles has $2.4 of debt for every $1 of equity.
This is higher than what I would like to see from a retailer, but it is optimistic that this ratio is improving. This is also slightly better than its rival Woolworths Group Ltd (ASX: WOW) at 2.8x based on its December 2023 financials.
Is Coles making sufficient profits to cover interest payments?
Another important metric to measure a company's financial health is the interest coverage ratio. It is a measure of how easily a company can pay the interest on its debts using its operating income.
For the last 12 months to December 2023, Coles generated an operating income of $1.7 billion. In fact, its operating profits have stayed consistently between $1.6 billion and $1.8 billion over the last four years.
From the operating profits, Coles spent $397 million on net financing costs during the same period. This expense has reduced from $431 million in FY20 as its improved debt levels offset the impact of interest rate increases.
These two figures give us an interest coverage ratio of 4.4x, indicating its current income is sufficient to cover interest expenses.
On the cash flow side, which can be different from the income statement, Coles makes an operating cash flow of $2.7 billion a year, which has been consistently moving between $2.7 billion and $2.8 billion since FY21. This is sufficient to cover its increased needs for capital expenditure (capex) of $1.7 billion and lease obligations of approximately $900 million a year.
Foolish takeaway
In this article, we reviewed a few important metrics to assess the financial health of Coles' balance sheet.
While its debt-to-equity ratio appears to be high, the company generates sufficient income to cover debt servicing expenses for now, in my opinion.
