Is JD Sports Fashion (LON:JD.) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, JD Sports Fashion Plc (LON:JD.) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for JD Sports Fashion

What Is JD Sports Fashion's Net Debt?

The image below, which you can click on for greater detail, shows that at August 2024 JD Sports Fashion had debt of UK£905.6m, up from UK£114.6m in one year. But it also has UK£946.3m in cash to offset that, meaning it has UK£40.7m net cash.

How Strong Is JD Sports Fashion's Balance Sheet?

According to the last reported balance sheet, JD Sports Fashion had liabilities of UK£2.32b due within 12 months, and liabilities of UK£4.20b due beyond 12 months. Offsetting these obligations, it had cash of UK£946.3m as well as receivables valued at UK£332.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£5.23b.

Given this deficit is actually higher than the company's market capitalization of UK£4.88b, we think shareholders really should watch JD Sports Fashion's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. JD Sports Fashion boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

One way JD Sports Fashion could vanquish its debt would be if it stops borrowing more but continues to grow EBIT at around 11%, as it did over the last year. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if JD Sports Fashion 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. JD Sports Fashion may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, JD Sports Fashion recorded free cash flow worth 74% 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.

Summing Up

While JD Sports Fashion does have more liabilities than liquid assets, it also has net cash of UK£40.7m. And it impressed us with free cash flow of UK£595m, being 74% of its EBIT. So we don't have any problem with JD Sports Fashion's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for JD Sports Fashion you should be aware of.

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.