Is Foot Locker (NYSE:FL) Using Too Much Debt?

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 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 note that Foot Locker, Inc. (NYSE:FL) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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 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.

View our latest analysis for Foot Locker

What Is Foot Locker's Net Debt?

The image below, which you can click on for greater detail, shows that at April 2022 Foot Locker had debt of US$450.0m, up from US$101.0m in one year. However, its balance sheet shows it holds US$551.0m in cash, so it actually has US$101.0m net cash.

How Healthy Is Foot Locker's Balance Sheet?

According to the last reported balance sheet, Foot Locker had liabilities of US$1.56b due within 12 months, and liabilities of US$3.11b due beyond 12 months. On the other hand, it had cash of US$551.0m and US$136.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$3.98b.

When you consider that this deficiency exceeds the company's US$2.82b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. Foot Locker boasts net cash, so it's fair to say it does not have a heavy debt load, even if it does have very significant liabilities, in total.

On top of that, Foot Locker grew its EBIT by 36% over the last twelve months, and that growth will make it easier to handle its debt. 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're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Foot Locker 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, Foot Locker produced sturdy free cash flow equating to 73% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

Although Foot Locker'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$101.0m. And we liked the look of last year's 36% year-on-year EBIT growth. So we are not troubled with Foot Locker's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with Foot Locker (at least 2 which don't sit too well with us) , and understanding them should be part of your investment process.

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.