We Think NIKE (NYSE:NKE) Can Stay On Top Of Its Debt

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that NIKE, Inc. (NYSE:NKE) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for NIKE

What Is NIKE's Net Debt?

The chart below, which you can click on for greater detail, shows that NIKE had US$9.43b in debt in August 2022; about the same as the year before. However, it does have US$11.9b in cash offsetting this, leading to net cash of US$2.45b.

How Strong Is NIKE's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that NIKE had liabilities of US$10.9b due within 12 months and liabilities of US$14.3b due beyond that. On the other hand, it had cash of US$11.9b and US$4.96b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$8.43b.

Given NIKE has a humongous market capitalization of US$134.0b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, NIKE boasts net cash, so it's fair to say it does not have a heavy debt load!

But the bad news is that NIKE has seen its EBIT plunge 18% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine NIKE's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. NIKE 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. During the last three years, NIKE produced sturdy free cash flow equating to 73% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

We could understand if investors are concerned about NIKE's liabilities, but we can be reassured by the fact it has has net cash of US$2.45b. The cherry on top was that in converted 73% of that EBIT to free cash flow, bringing in US$4.4b. So we don't have any problem with NIKE's use of debt. Over time, share prices tend to follow earnings per share, so if you're interested in NIKE, you may well want to click here to check an interactive graph of its earnings per share history.

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.

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

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.