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 note that Fortinet, Inc. (NASDAQ:FTNT) does have debt on its balance sheet. 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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Fortinet's Debt?
As you can see below, at the end of June 2021, Fortinet had US$987.5m of debt, up from none a year ago. Click the image for more detail. However, it does have US$3.11b in cash offsetting this, leading to net cash of US$2.13b.
How Healthy Is Fortinet's Balance Sheet?
We can see from the most recent balance sheet that Fortinet had liabilities of US$2.00b falling due within a year, and liabilities of US$2.51b due beyond that. Offsetting this, it had US$3.11b in cash and US$587.8m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$807.7m.
Having regard to Fortinet'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$55.3b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Fortinet 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 Fortinet has boosted its EBIT by 33%, thus reducing the spectre of future debt repayments. 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 Fortinet can strengthen its balance sheet over time. 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. While Fortinet 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. Happily for any shareholders, Fortinet 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.
We could understand if investors are concerned about Fortinet's liabilities, but we can be reassured by the fact it has has net cash of US$2.13b. And it impressed us with free cash flow of US$1.1b, being 211% of its EBIT. So we don't think Fortinet's use of debt is risky. 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. To that end, you should be aware of the 1 warning sign we've spotted with Fortinet .
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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.
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