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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that DICK'S Sporting Goods, Inc. (NYSE:DKS) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is DICK'S Sporting Goods's Net Debt?
As you can see below, at the end of January 2021, DICK'S Sporting Goods had US$418.5m of debt, up from US$224.1m a year ago. Click the image for more detail. But it also has US$1.66b in cash to offset that, meaning it has US$1.24b net cash.
A Look At DICK'S Sporting Goods' Liabilities
According to the last reported balance sheet, DICK'S Sporting Goods had liabilities of US$2.55b due within 12 months, and liabilities of US$2.86b due beyond 12 months. Offsetting this, it had US$1.66b in cash and US$59.5m in receivables that were due within 12 months. So it has liabilities totalling US$3.70b more than its cash and near-term receivables, combined.
DICK'S Sporting Goods has a market capitalization of US$7.68b, so it could very likely raise cash to ameliorate 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, DICK'S Sporting Goods boasts net cash, so it's fair to say it does not have a heavy debt load!
Better yet, DICK'S Sporting Goods grew its EBIT by 107% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. 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 DICK'S Sporting Goods'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. DICK'S Sporting Goods 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. Happily for any shareholders, DICK'S Sporting Goods actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
Although DICK'S Sporting Goods'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$1.24b. The cherry on top was that in converted 113% of that EBIT to free cash flow, bringing in US$1.3b. So is DICK'S Sporting Goods's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for DICK'S Sporting Goods you should be aware of, and 1 of them is concerning.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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