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Abercrombie & Fitch (NYSE:ANF) Has A Pretty Healthy Balance Sheet

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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.' 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, Abercrombie & Fitch Co. (NYSE:ANF) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Abercrombie & Fitch

What Is Abercrombie & Fitch's Debt?

You can click the graphic below for the historical numbers, but it shows that Abercrombie & Fitch had US$303.9m of debt in April 2022, down from US$344.3m, one year before. However, its balance sheet shows it holds US$468.4m in cash, so it actually has US$164.5m net cash.

debt-equity-history-analysis
debt-equity-history-analysis

A Look At Abercrombie & Fitch's Liabilities

Zooming in on the latest balance sheet data, we can see that Abercrombie & Fitch had liabilities of US$853.0m due within 12 months and liabilities of US$1.05b due beyond that. Offsetting this, it had US$468.4m in cash and US$88.8m in receivables that were due within 12 months. So its liabilities total US$1.35b more than the combination of its cash and short-term receivables.

Given this deficit is actually higher than the company's market capitalization of US$948.4m, we think shareholders really should watch Abercrombie & Fitch's debt levels, like a parent watching their child ride a bike for the first time. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution. Abercrombie & Fitch 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.

Also good is that Abercrombie & Fitch grew its EBIT at 14% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Abercrombie & Fitch's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Abercrombie & Fitch has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last two years, Abercrombie & Fitch recorded free cash flow worth a fulsome 87% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing up

Although Abercrombie & Fitch'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$164.5m. And it impressed us with free cash flow of US$82m, being 87% of its EBIT. So we don't have any problem with Abercrombie & Fitch's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Abercrombie & Fitch (of which 2 are potentially serious!) you should know about.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.