Howard Marks put it well when he said that instead of worrying about stock price volatility, “the possibility of permanent loss is the risk I worry about…and every practical investor I know worries about.” . When we think about the risk of a company, we always like to look at its use of debt, since debt overload can lead to bankruptcy. Like many other companies JD Sports Fashion plc (LON:JD.) makes use of debt. But is this debt a concern for shareholders?
When is debt dangerous?
Generally speaking, debt only becomes a real problem when a company cannot easily pay it off, either by raising capital or from its own cash flow. An integral part of capitalism is the process of “creative destruction” in which bankers ruthlessly liquidate failing companies. However, a more common (but still expensive) situation is when a company must dilute shareholders at a cheap share price simply to control debt. Of course, debt can be an important tool in business, particularly capital-intensive businesses. The first step in considering a company’s debt levels is to consider its cash and debt together.
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How much debt does JD Sports Fashion have?
The image below, which you can click on for more details, shows that JD Sports Fashion had £124.8m in debt at the end of July 2022, a reduction of £309.6m over one year. However, he has £1.14 trillion in cash to make up for this, leading to net cash of £1.01 trillion.
LSE: J.D. Debt to Equity History January 17, 2023
How strong is JD Sports Fashion’s balance sheet?
If we zoom in on the latest balance sheet data, we can see that JD Sports Fashion had liabilities of £2.04 trillion maturing in 12 months and liabilities of £3.01 trillion maturing beyond that. To offset this, it had £1.14 billion in cash and £314.7 million in accounts receivable due within 12 months. Therefore, its liabilities exceed the sum of its cash and receivables (short-term) by £3.6bn.
While this may sound like a lot, it’s not too bad as JD Sports Fashion has a whopping £8.34bn market cap, so it could probably strengthen its balance sheet by raising capital if need be. But clearly we should definitely take a close look at whether you can manage your debt without dilution. Despite its notable liabilities, JD Sports Fashion boasts net cash, so it’s fair to say it doesn’t have a huge debt load.
It’s also good that JD Sports Fashion increased its EBIT by 12% over the past year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when analyzing debt. But it is future earnings, more than anything, that will determine JD Sports Fashion’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check this out free report showing analyst earnings forecasts.
Finally, a business needs free cash flow to pay down debt; accounting profits are simply not enough. While JD Sports Fashion has net cash on its balance sheet, its ability to convert earnings before interest and taxes (EBIT) into free cash flow is still worth taking a look at, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, JD Sports Fashion produced more free cash flow than EBIT. That kind of strong cash conversion excites us as much as the crowd when the beat drops at a Daft Punk concert.
Although JD Sports Fashion’s balance sheet is not particularly strong, due to total liabilities, it is clearly positive to see it have net cash of £1.01bn. And it impressed us with free cash flow of £592m, 104% of its EBIT. So is JD Sports Fashion’s debt a risk? It doesn’t seem so to us. There is no doubt that we learn more about balance sheet debt. But ultimately, all companies may contain risks that exist off the balance sheet. These risks can be difficult to detect. All companies have them, and we have seen 2 Warning Signs for JD Sports Fashion you should know about
If you are interested in investing in companies that can generate profit without the burden of debt, check this out free list of growing businesses that have net cash on the balance sheet.
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This Simply Wall St article is general in nature. We provide feedback based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell any stock, and it does not take into account your goals or financial situation. Our goal is to provide you with long-term focused analysis driven by fundamental data. Please note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative material. Simply Wall St does not have a position in any of the mentioned stocks.