Health Check: How Prudently Does GameStop (NYSE:GME) Use Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies GameStop Corp. (NYSE:GME) makes use of debt. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

See our latest analysis for GameStop

What Is GameStop's Debt?

The image below, which you can click on for greater detail, shows that GameStop had debt of US$44.6m at the end of January 2022, a reduction from US$362.7m over a year. But on the other hand it also has US$1.27b in cash, leading to a US$1.23b net cash position.

How Strong Is GameStop's Balance Sheet?

According to the last reported balance sheet, GameStop had liabilities of US$1.35b due within 12 months, and liabilities of US$542.1m due beyond 12 months. Offsetting these obligations, it had cash of US$1.27b as well as receivables valued at US$309.7m due within 12 months. So its liabilities total US$315.7m more than the combination of its cash and short-term receivables.

Given GameStop has a market capitalization of US$9.50b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, GameStop also has more cash than debt, so we're pretty confident it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if GameStop 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.

Over 12 months, GameStop reported revenue of US$6.0b, which is a gain of 18%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.

So How Risky Is GameStop?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And the fact is that over the last twelve months GameStop lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through US$496m of cash and made a loss of US$381m. Given it only has net cash of US$1.23b, the company may need to raise more capital if it doesn't reach break-even soon. Overall, we'd say the stock is a bit risky, and we're usually very cautious until we see positive free cash flow. 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, we've discovered 3 warning signs for GameStop that you should be aware of before investing here.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.