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Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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, Elastic N.V. (NYSE:ESTC) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
What Is Elastic's Net Debt?
The image below, which you can click on for greater detail, shows that at October 2021 Elastic had debt of US$566.0m, up from none in one year. But it also has US$878.7m in cash to offset that, meaning it has US$312.7m net cash.
How Strong Is Elastic's Balance Sheet?
According to the last reported balance sheet, Elastic had liabilities of US$480.4m due within 12 months, and liabilities of US$631.5m due beyond 12 months. On the other hand, it had cash of US$878.7m and US$157.8m worth of receivables due within a year. So its liabilities total US$75.3m more than the combination of its cash and short-term receivables.
This state of affairs indicates that Elastic's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$8.02b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Elastic boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Elastic'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.
In the last year Elastic wasn't profitable at an EBIT level, but managed to grow its revenue by 44%, to US$734m. With any luck the company will be able to grow its way to profitability.
So How Risky Is Elastic?
Although Elastic had an earnings before interest and tax (EBIT) loss over the last twelve months, it generated positive free cash flow of US$15m. So although it is loss-making, it doesn't seem to have too much near-term balance sheet risk, keeping in mind the net cash. One positive is that Elastic is growing revenue apace, which makes it easier to sell a growth story and raise capital if need be. But that doesn't change our opinion that the stock 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. For instance, we've identified 4 warning signs for Elastic that you should be aware of.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.