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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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies ANSYS, Inc. (NASDAQ:ANSS) makes use of debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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 ANSYS's Net Debt?
The image below, which you can click on for greater detail, shows that at June 2020 ANSYS had debt of US$423.7m, up from none in one year. But on the other hand it also has US$745.0m in cash, leading to a US$321.3m net cash position.
How Strong Is ANSYS's Balance Sheet?
We can see from the most recent balance sheet that ANSYS had liabilities of US$543.8m falling due within a year, and liabilities of US$690.0m due beyond that. Offsetting these obligations, it had cash of US$745.0m as well as receivables valued at US$503.3m due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.
Having regard to ANSYS'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$27.1b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, ANSYS boasts net cash, so it's fair to say it does not have a heavy debt load!
But the bad news is that ANSYS has seen its EBIT plunge 12% in the last twelve months. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine ANSYS's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. ANSYS 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, ANSYS actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
While it is always sensible to investigate a company's debt, in this case ANSYS has US$321.3m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$494m, being 101% of its EBIT. So we don't think ANSYS's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with ANSYS .
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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