Health Check: How Carefully Does GameStop (NYSE:GME) Use Debt?
Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The greatest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. Like many other companies GameStop Corp. (NYSE:GME) uses debt. But the more important question is: what risk does this debt create?
What risk does debt carry?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business 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.
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What is GameStop’s debt?
The image below, which you can click on for more details, shows GameStop had $44.6 million in debt at the end of January 2022, down from $362.7 million year-over-year. But on the other hand, it also has $1.27 billion in cash, resulting in a net cash position of $1.23 billion.
How strong is GameStop’s balance sheet?
According to the last published balance sheet, GameStop had liabilities of US$1.35 billion due within 12 months and liabilities of US$542.1 million due beyond 12 months. As compensation for these obligations, it had cash of US$1.27 billion and receivables valued at US$309.7 million due within 12 months. Thus, its liabilities total $315.7 million more than the combination of its cash and short-term receivables.
Given that GameStop has a market capitalization of US$9.50 billion, it’s hard to believe that these liabilities pose much of a threat. That said, it is clear that we must continue to monitor its record, lest it deteriorate. While it has liabilities to note, GameStop also has more cash than debt, so we’re pretty confident it can manage its debt safely. When analyzing debt levels, the balance sheet is the obvious starting point. But ultimately, the company’s future profitability will decide whether GameStop can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Year-over-year, GameStop reported revenue of $6.0 billion, an 18% gain, although it reported no earnings before interest and taxes. We generally like to see faster growth from unprofitable companies, but each in its own way.
So how risky is GameStop?
We have no doubt that loss-making companies are, in general, more risky than profitable companies. And the thing is, over the last twelve months, GameStop has been losing money in earnings before interest and taxes (EBIT). Indeed, during this period, it burned $496 million in cash and suffered a loss of $381 million. Given that it only has net cash of US$1.23 billion, the company may need to raise more capital if it doesn’t break even soon. Overall, we would say the stock is a bit risky and we are generally very cautious until we see positive free cash flow. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, we found 3 warning signs for GameStop which you should be aware of before investing here.
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% freeright now.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.