Foot Locker (NYSE:FL) Use Of Debt Could Be Considered Risky

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.' 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. Importantly, Foot Locker, Inc. (NYSE:FL) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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.

Check out our latest analysis for Foot Locker

How Much Debt Does Foot Locker Carry?

The chart below, which you can click on for greater detail, shows that Foot Locker had US$440.0m in debt in November 2024; about the same as the year before. However, because it has a cash reserve of US$211.0m, its net debt is less, at about US$229.0m.

How Healthy Is Foot Locker's Balance Sheet?

The latest balance sheet data shows that Foot Locker had liabilities of US$1.43b due within a year, and liabilities of US$2.56b falling due after that. Offsetting these obligations, it had cash of US$211.0m as well as receivables valued at US$160.0m due within 12 months. So its liabilities total US$3.62b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the US$1.83b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Foot Locker would likely require a major re-capitalisation if it had to pay its creditors today.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Foot Locker's net debt is only 0.69 times its EBITDA. And its EBIT covers its interest expense a whopping 16.3 times over. So we're pretty relaxed about its super-conservative use of debt. It is just as well that Foot Locker's load is not too heavy, because its EBIT was down 48% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Foot Locker can strengthen its balance sheet over time. 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. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Foot Locker saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

On the face of it, Foot Locker's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Taking into account all the aforementioned factors, it looks like Foot Locker has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. Even though Foot Locker lost money on the bottom line, its positive EBIT suggests the business itself has potential. So you might want to check out how earnings have been trending over the last few years.

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.

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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.