DICK'S Sporting Goods (NYSE:DKS) Has A Somewhat Strained Balance Sheet
The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. We note that DICK'S Sporting Goods, Inc. (NYSE:DKS) does have debt on its balance sheet. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for DICK'S Sporting Goods
What Is DICK'S Sporting Goods's Net Debt?
The image below, which you can click on for greater detail, shows that at August 2019 DICK'S Sporting Goods had debt of US$441.5m, up from US$171.1m in one year. However, it also had US$116.7m in cash, and so its net debt is US$324.8m.
A Look At DICK'S Sporting Goods's Liabilities
The latest balance sheet data shows that DICK'S Sporting Goods had liabilities of US$1.93b due within a year, and liabilities of US$3.22b falling due after that. On the other hand, it had cash of US$116.7m and US$68.5m worth of receivables due within a year. So its liabilities total US$4.96b more than the combination of its cash and short-term receivables.
This deficit casts a shadow over the US$3.08b 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, DICK'S Sporting Goods would probably need a major re-capitalization if its creditors were to demand repayment.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
DICK'S Sporting Goods's net debt is only 0.48 times its EBITDA. And its EBIT easily covers its interest expense, being 32.4 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. But the bad news is that DICK'S Sporting Goods has seen its EBIT plunge 13% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. 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 DICK'S Sporting Goods'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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, DICK'S Sporting Goods recorded free cash flow worth 66% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
Our View
Mulling over DICK'S Sporting Goods's attempt at staying on top of its total liabilities, we're certainly not enthusiastic. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Once we consider all the factors above, together, it seems to us that DICK'S Sporting Goods's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check DICK'S Sporting Goods's dividend history, without delay!
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.
