Does Academy Sports and Outdoors (NASDAQ:ASO) Have A Healthy Balance Sheet?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Academy Sports and Outdoors, Inc. (NASDAQ:ASO) makes use of debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Academy Sports and Outdoors

What Is Academy Sports and Outdoors's Net Debt?

The image below, which you can click on for greater detail, shows that Academy Sports and Outdoors had debt of US$586.4m at the end of October 2023, a reduction from US$685.8m over a year. However, it also had US$274.8m in cash, and so its net debt is US$311.5m.

How Strong Is Academy Sports and Outdoors' Balance Sheet?

The latest balance sheet data shows that Academy Sports and Outdoors had liabilities of US$1.17b due within a year, and liabilities of US$1.96b falling due after that. Offsetting this, it had US$274.8m in cash and US$17.7m in receivables that were due within 12 months. So it has liabilities totalling US$2.84b more than its cash and near-term receivables, combined.

This deficit isn't so bad because Academy Sports and Outdoors is worth US$4.78b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Academy Sports and Outdoors's net debt is only 0.40 times its EBITDA. And its EBIT easily covers its interest expense, being 14.9 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. But the bad news is that Academy Sports and Outdoors has seen its EBIT plunge 19% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Academy Sports and Outdoors 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 company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Academy Sports and Outdoors produced sturdy free cash flow equating to 56% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

We feel some trepidation about Academy Sports and Outdoors's difficulty EBIT growth rate, but we've got positives to focus on, too. For example, its interest cover and net debt to EBITDA give us some confidence in its ability to manage its debt. Looking at all the angles mentioned above, it does seem to us that Academy Sports and Outdoors is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. In light of our reservations about the company's balance sheet, it seems sensible to check if insiders have been selling shares recently.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.