I've been enjoying the thought-provoking debate between Arne Alsin and James Cramer on Kohl's (KSS:NYSE - news - boards), and thought I'd weigh in with some numbers that raise real warning flags for me.

Kohl's has been expanding rapidly -- and, I might add, appears to be executing superbly, as same-store sales were up a remarkable 14.8% in December . But I always worry when I see a high-growth company -- especially in the highly competitive, fickle retail industry -- that has negative and declining free cash flow and rapidly rising debt. Here are the numbers that give me pause.

Free Cash Flow

Kohl's free cash flow (defined as operating cash flow, excluding the tax benefit from exercise of stock options, minus net capital expenditures) was only slightly negative for the 12 months ending in the third quarter of 1998, but worsened significantly over the next two years -- despite a rapid rise in net income -- as the following table shows.

The Riskier Financials of Kohl's
Category	Trailing 12 months ending Q3 98	Trailing 12 months ending Q3 99	Trailing 12 months ending Q3 00
Net income	$170,802	$231,628	$314,230
Operating cash flow*	$162,584	$185,377	($196,577)
Net cap expend.	$222,303	$543,296	$495,474
Free cash flow	($59,719)	($357,919)	($692,051)
Source: company reports * Excluding tax benefit from exercise of stock options

Negative free cash flow is not unusual for a rapidly growing company, especially in the retail sector, because new stores are costly (e.g., capex rises) and inventory levels increase to stock them, which hurts operating cash flow. As long as the new stores thrive and generate high returns on capital, rapid growth -- even at the expense of current free cash flow -- is a good thing for shareholders.

But the negative free cash flow has to be paid for somehow, typically by taking on debt or issuing stock. At modest levels, neither of these things is troubling, but if severely negative free cash flow makes it necessary to issue a great deal of stock, this triggers meaningful dilution for existing shareholders. Or, if the company issues debt, this increases risk should the company encounter difficulties. I can't even begin to count how many retailers have gone out of business by taking on too much debt and then seeing their fortunes decline.

Debt

While Kohl's has raised some capital by issuing stock ($328.5 million over the past three years), its primary method of financing these free cash flow deficits has been via issuing debt. This graph shows Kohl's net debt (total debt minus cash and short-term investments) since the first quarter of 1997.

Over the past six quarters, Kohl's net debt has increased 264%, from $292 million to $1.063 billion. For perspective, that's equal to 3.4 years of Kohl's trailing 12-month net income. Both the magnitude of this debt and its rapid rise are very worrisome.

Conclusion

I think Kohl's is a very well-run company with bright prospects. But there's a big difference between liking the company and liking the stock. At Friday's closing price of $65.94, Kohl's is trading at 50.3 times analysts' consensus estimated earnings for fiscal 2001 (ending next month) of $1.31 a share. That's pricey any way you look at it. With so many undervalued stocks representing solid companies, it doesn't make any sense, to me at least, to buy a stock that is clearly fully valued -- if not significantly overvalued.