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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Stamps.com Inc. (NASDAQ:STMP) does use debt in its business. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Stamps.com's Debt?
The image below, which you can click on for greater detail, shows that Stamps.com had debt of US$26.2m at the end of September 2020, a reduction from US$68.5m over a year. But on the other hand it also has US$389.6m in cash, leading to a US$363.4m net cash position.
How Healthy Is Stamps.com's Balance Sheet?
We can see from the most recent balance sheet that Stamps.com had liabilities of US$206.1m falling due within a year, and liabilities of US$95.6m due beyond that. Offsetting these obligations, it had cash of US$389.6m as well as receivables valued at US$77.9m due within 12 months. So it can boast US$165.8m more liquid assets than total liabilities.
This surplus suggests that Stamps.com has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Stamps.com has more cash than debt is arguably a good indication that it can manage its debt safely.
On top of that, Stamps.com grew its EBIT by 46% over the last twelve months, and that growth will make it easier to handle its debt. 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 Stamps.com'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Stamps.com 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. Happily for any shareholders, Stamps.com 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.
While it is always sensible to investigate a company's debt, in this case Stamps.com has US$363.4m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 131% of that EBIT to free cash flow, bringing in US$212m. So is Stamps.com's debt a risk? It doesn't seem so to us. 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. For example, we've discovered 3 warning signs for Stamps.com (1 makes us a bit uncomfortable!) that you should be aware of before investing here.
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.
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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