Is American Eagle Outfitters (NYSE:AEO) Using Too Much Debt?

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.' 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. Importantly, American Eagle Outfitters, Inc. (NYSE:AEO) does carry debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for American Eagle Outfitters

How Much Debt Does American Eagle Outfitters Carry?

You can click the graphic below for the historical numbers, but it shows that as of January 2022 American Eagle Outfitters had US$341.0m of debt, an increase on US$325.3m, over one year. But on the other hand it also has US$434.8m in cash, leading to a US$93.8m net cash position.

A Look At American Eagle Outfitters' Liabilities

We can see from the most recent balance sheet that American Eagle Outfitters had liabilities of US$842.9m falling due within a year, and liabilities of US$1.52b due beyond that. Offsetting this, it had US$434.8m in cash and US$286.7m in receivables that were due within 12 months. So it has liabilities totalling US$1.64b more than its cash and near-term receivables, combined.

This deficit isn't so bad because American Eagle Outfitters is worth US$2.95b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, American Eagle Outfitters also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that American Eagle Outfitters grew its EBIT by 5,752% over twelve months. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine American Eagle Outfitters's ability to maintain a healthy balance sheet going forward. 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. American Eagle Outfitters 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. In the last three years, American Eagle Outfitters's free cash flow amounted to 37% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

Although American Eagle Outfitters's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$93.8m. And it impressed us with its EBIT growth of 5,752% over the last year. So we don't have any problem with American Eagle Outfitters's use of debt. 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. For example, we've discovered 4 warning signs for American Eagle Outfitters (1 is potentially serious!) that you should be aware of before investing here.

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.