Here's Why JD Sports Fashion (LON:JD.) Can Manage Its Debt Responsibly

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We can see that JD Sports Fashion Plc (LON:JD.) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for JD Sports Fashion

What Is JD Sports Fashion's Debt?

You can click the graphic below for the historical numbers, but it shows that JD Sports Fashion had UK£114.6m of debt in July 2023, down from UK£124.8m, one year before. But on the other hand it also has UK£1.39b in cash, leading to a UK£1.28b net cash position.

How Healthy Is JD Sports Fashion's Balance Sheet?

According to the last reported balance sheet, JD Sports Fashion had liabilities of UK£2.50b due within 12 months, and liabilities of UK£2.92b due beyond 12 months. On the other hand, it had cash of UK£1.39b and UK£292.1m worth of receivables due within a year. So its liabilities total UK£3.73b more than the combination of its cash and short-term receivables.

This deficit isn't so bad because JD Sports Fashion is worth UK£7.76b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. Despite its noteworthy liabilities, JD Sports Fashion boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that JD Sports Fashion has increased its EBIT by 7.3% 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 JD Sports Fashion can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While JD Sports Fashion has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, JD Sports Fashion generated free cash flow amounting to a very robust 80% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Summing Up

Although JD Sports Fashion's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of UK£1.28b. And it impressed us with free cash flow of UK£813m, being 80% of its EBIT. So we are not troubled with JD Sports Fashion's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 2 warning signs we've spotted with JD Sports Fashion .

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.