American Eagle Outfitters (NYSE:AEO) Has A Somewhat Strained Balance Sheet

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies American Eagle Outfitters, Inc. (NYSE:AEO) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. 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 American Eagle Outfitters

What Is American Eagle Outfitters's Debt?

The image below, which you can click on for greater detail, shows that American Eagle Outfitters had debt of US$8.91m at the end of January 2023, a reduction from US$341.0m over a year. However, it does have US$170.2m in cash offsetting this, leading to net cash of US$161.3m.

How Healthy Is American Eagle Outfitters' Balance Sheet?

The latest balance sheet data shows that American Eagle Outfitters had liabilities of US$768.9m due within a year, and liabilities of US$1.05b falling due after that. Offsetting these obligations, it had cash of US$170.2m as well as receivables valued at US$242.4m due within 12 months. So it has liabilities totalling US$1.41b more than its cash and near-term receivables, combined.

This deficit isn't so bad because American Eagle Outfitters is worth US$2.51b, 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. Despite its noteworthy liabilities, American Eagle Outfitters boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact American Eagle Outfitters's saving grace is its low debt levels, because its EBIT has tanked 55% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 American Eagle Outfitters 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 company can only pay off debt with cold hard cash, not accounting profits. While American Eagle Outfitters 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. In the last three years, American Eagle Outfitters's free cash flow amounted to 33% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While American Eagle Outfitters does have more liabilities than liquid assets, it also has net cash of US$161.3m. So although we see some areas for improvement, we're not too worried about American Eagle Outfitters's balance sheet. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 3 warning signs we've spotted with American Eagle Outfitters .

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.