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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.' 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. As with many other companies Adobe Inc. (NASDAQ:ADBE) makes use of debt. But is this debt a concern to shareholders?
When Is Debt A Problem?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Adobe Carry?
As you can see below, Adobe had US$4.12b of debt, at November 2020, which is about the same as the year before. You can click the chart for greater detail. But it also has US$5.99b in cash to offset that, meaning it has US$1.88b net cash.
How Strong Is Adobe's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Adobe had liabilities of US$5.51b due within 12 months and liabilities of US$5.51b due beyond that. On the other hand, it had cash of US$5.99b and US$1.40b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$3.63b.
Having regard to Adobe's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the US$239.9b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Adobe also has more cash than debt, so we're pretty confident it can manage its debt safely.
Also positive, Adobe grew its EBIT by 30% in the last year, and that should make it easier to pay down debt, going forward. 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 Adobe's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Adobe 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. Happily for any shareholders, Adobe actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
We could understand if investors are concerned about Adobe's liabilities, but we can be reassured by the fact it has has net cash of US$1.88b. And it impressed us with free cash flow of US$4.9b, being 123% of its EBIT. So we don't think Adobe's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Adobe (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.
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.
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. 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.
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