GameStop (NYSE:GME) Has Debt But No Earnings; Should You Worry?

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.' 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. As with many other companies GameStop Corp. (NYSE:GME) makes use of debt. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. 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. 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.

See our latest analysis for GameStop

What Is GameStop's Debt?

As you can see below, at the end of May 2020, GameStop had US$552.2m of debt, up from US$468.9m a year ago. Click the image for more detail. However, it does have US$570.3m in cash offsetting this, leading to net cash of US$18.1m.

How Strong Is GameStop's Balance Sheet?

According to the last reported balance sheet, GameStop had liabilities of US$1.52b due within 12 months, and liabilities of US$514.3m due beyond 12 months. On the other hand, it had cash of US$570.3m and US$86.7m worth of receivables due within a year. So it has liabilities totalling US$1.4b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the US$322.5m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, GameStop would probably need a major re-capitalization if its creditors were to demand repayment. GameStop 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. 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 GameStop 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.

In the last year GameStop had a loss before interest and tax, and actually shrunk its revenue by 26%, to US$5.9b. To be frank that doesn't bode well.

So How Risky Is GameStop?

While GameStop lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow US$135m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. We're not impressed by its revenue growth, so until we see some positive sustainable EBIT, we consider the stock to be high risk. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 1 warning sign with GameStop , 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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