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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, The ODP Corporation (NASDAQ:ODP) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is ODP's Debt?
The image below, which you can click on for greater detail, shows that ODP had debt of US$144.0m at the end of December 2023, a reduction from US$150.0m over a year. However, it does have US$392.0m in cash offsetting this, leading to net cash of US$248.0m.
A Look At ODP's Liabilities
According to the last reported balance sheet, ODP had liabilities of US$1.69b due within 12 months, and liabilities of US$1.09b due beyond 12 months. On the other hand, it had cash of US$392.0m and US$491.0m worth of receivables due within a year. So its liabilities total US$1.90b 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$1.87b, we think shareholders really should watch ODP'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. Given that ODP has more cash than debt, we're pretty confident it can handle its debt, despite the fact that it has a lot of liabilities in total.
While ODP doesn't seem to have gained much on the EBIT line, at least earnings remain stable for now. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine ODP'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 company can only pay off debt with cold hard cash, not accounting profits. ODP may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the most recent three years, ODP recorded free cash flow worth 69% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
Summing Up
Although ODP'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$248.0m. The cherry on top was that in converted 69% of that EBIT to free cash flow, bringing in US$226m. So we are not troubled with ODP's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 2 warning signs for ODP that you should be aware of.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.