Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. Importantly, DICK'S Sporting Goods, Inc. (NYSE:DKS) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
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. If things get really bad, the lenders can take control of the business. 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, 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. When we think about a company's use of debt, we first look at cash and debt together.
What Is DICK'S Sporting Goods's Debt?
As you can see below, at the end of July 2021, DICK'S Sporting Goods had US$433.5m of debt, up from US$404.6m a year ago. Click the image for more detail. However, it does have US$2.24b in cash offsetting this, leading to net cash of US$1.80b.
How Strong Is DICK'S Sporting Goods' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that DICK'S Sporting Goods had liabilities of US$2.57b due within 12 months and liabilities of US$2.81b due beyond that. On the other hand, it had cash of US$2.24b and US$89.4m worth of receivables due within a year. So it has liabilities totalling US$3.05b more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since DICK'S Sporting Goods has a huge market capitalization of US$11.8b, 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. 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!
Even more impressive was the fact that DICK'S Sporting Goods grew its EBIT by 266% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. 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 DICK'S Sporting Goods 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. 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. During the last three years, DICK'S Sporting Goods generated free cash flow amounting to a very robust 99% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
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$1.80b. The cherry on top was that in converted 99% of that EBIT to free cash flow, bringing in US$1.4b. So is DICK'S Sporting Goods's debt a risk? It doesn't seem so to us. 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 DICK'S Sporting Goods has 3 warning signs (and 1 which doesn't sit too well with us) we think you should know about.
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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