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

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.' 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 can see that American Eagle Outfitters, Inc. (NYSE:AEO) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out 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 American Eagle Outfitters had US$3.23m of debt in July 2023, down from US$376.5m, one year before. However, it does have US$175.3m in cash offsetting this, leading to net cash of US$172.1m.

A Look At American Eagle Outfitters' Liabilities

According to the last reported balance sheet, American Eagle Outfitters had liabilities of US$762.5m due within 12 months, and liabilities of US$996.4m due beyond 12 months. Offsetting this, it had US$175.3m in cash and US$271.3m in receivables that were due within 12 months. So its liabilities total US$1.31b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since American Eagle Outfitters has a market capitalization of US$3.13b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. 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.

On the other hand, American Eagle Outfitters's EBIT dived 10%, over the last year. 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 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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 37% 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$172.1m. So we are not troubled with American Eagle Outfitters's debt use. 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. To that end, you should be aware of the 2 warning signs we've spotted with American Eagle Outfitters .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.