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.' 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. We can see that DICK'S Sporting Goods, Inc. (NYSE:DKS) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is DICK'S Sporting Goods's Debt?
You can click the graphic below for the historical numbers, but it shows that as of October 2021 DICK'S Sporting Goods had US$441.2m of debt, an increase on US$411.3m, over one year. However, it does have US$1.37b in cash offsetting this, leading to net cash of US$931.7m.
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$2.67b due within 12 months and liabilities of US$2.80b due beyond that. Offsetting these obligations, it had cash of US$1.37b as well as receivables valued at US$90.2m due within 12 months. So its liabilities total US$4.01b more than the combination of its cash and short-term receivables.
DICK'S Sporting Goods has a market capitalization of US$9.31b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. 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 166% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. 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. While DICK'S Sporting Goods 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. During the last three years, DICK'S Sporting Goods generated free cash flow amounting to a very robust 90% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
While DICK'S Sporting Goods does have more liabilities than liquid assets, it also has net cash of US$931.7m. The cherry on top was that in converted 90% of that EBIT to free cash flow, bringing in US$1.3b. So we don't think DICK'S Sporting Goods's use of debt is risky. 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. Be aware that DICK'S Sporting Goods is showing 3 warning signs in our investment analysis , and 1 of those can't be ignored...
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.
What are the risks and opportunities for DICK'S Sporting Goods?
Trading at 8.4% below our estimate of its fair value
High level of non-cash earnings
Significant insider selling over the past 3 months
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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.