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The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We note that Amdocs Limited (NASDAQ:DOX) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Amdocs's Debt?
As you can see below, at the end of September 2020, Amdocs had US$744.0m of debt, up from none a year ago. Click the image for more detail. But on the other hand it also has US$983.9m in cash, leading to a US$239.9m net cash position.
How Healthy Is Amdocs' Balance Sheet?
The latest balance sheet data shows that Amdocs had liabilities of US$1.22b due within a year, and liabilities of US$1.46b falling due after that. Offsetting these obligations, it had cash of US$983.9m as well as receivables valued at US$919.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$773.2m.
Given Amdocs has a market capitalization of US$9.13b, 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. Despite its noteworthy liabilities, Amdocs boasts net cash, so it's fair to say it does not have a heavy debt load!
Fortunately, Amdocs grew its EBIT by 4.4% in the last year, making that debt load look even more manageable. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Amdocs 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 company can only pay off debt with cold hard cash, not accounting profits. Amdocs 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, Amdocs recorded free cash flow worth 77% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
We could understand if investors are concerned about Amdocs's liabilities, but we can be reassured by the fact it has has net cash of US$239.9m. The cherry on top was that in converted 77% of that EBIT to free cash flow, bringing in US$452m. So is Amdocs's debt a risk? It doesn't seem so to us. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 1 warning sign for Amdocs you should be aware of.
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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