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, Sapiens International Corporation N.V. (NASDAQ:SPNS) does carry debt. But the real question is whether this debt is making the company risky.
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. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
What Is Sapiens International's Net Debt?
The image below, which you can click on for greater detail, shows that at March 2020 Sapiens International had debt of US$78.9m, up from US$68.6m in one year. However, its balance sheet shows it holds US$79.6m in cash, so it actually has US$674.0k net cash.
How Healthy Is Sapiens International's Balance Sheet?
According to the last reported balance sheet, Sapiens International had liabilities of US$129.2m due within 12 months, and liabilities of US$111.3m due beyond 12 months. On the other hand, it had cash of US$79.6m and US$68.1m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$92.8m.
Given Sapiens International has a market capitalization of US$1.21b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Sapiens International also has more cash than debt, so we're pretty confident it can manage its debt safely.
In addition to that, we're happy to report that Sapiens International has boosted its EBIT by 51%, thus reducing the spectre of future debt repayments. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Sapiens International can strengthen its balance sheet over time. 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. While Sapiens International 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. During the last three years, Sapiens International generated free cash flow amounting to a very robust 99% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
We could understand if investors are concerned about Sapiens International's liabilities, but we can be reassured by the fact it has has net cash of US$674.0k. And it impressed us with free cash flow of US$44m, being 99% of its EBIT. So is Sapiens International's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with Sapiens International , and understanding them should be part of your investment process.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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. Thank you for reading.