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Is Guidewire Software (NYSE:GWRE) Using Too Much Debt?

Simply Wall St

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 Guidewire Software, Inc. (NYSE:GWRE) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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 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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Guidewire Software

How Much Debt Does Guidewire Software Carry?

The chart below, which you can click on for greater detail, shows that Guidewire Software had US$317.3m in debt in July 2019; about the same as the year before. But on the other hand it also has US$1.12b in cash, leading to a US$806.9m net cash position.

NYSE:GWRE Historical Debt, September 9th 2019

How Strong Is Guidewire Software's Balance Sheet?

The latest balance sheet data shows that Guidewire Software had liabilities of US$232.3m due within a year, and liabilities of US$360.5m falling due after that. Offsetting these obligations, it had cash of US$1.12b as well as receivables valued at US$175.2m due within 12 months. So it can boast US$706.6m more liquid assets than total liabilities.

This surplus suggests that Guidewire Software has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Guidewire Software boasts net cash, so it's fair to say it does not have a heavy debt load!

Although Guidewire Software made a loss at the EBIT level, last year, it was also good to see that it generated US$1.5m in EBIT over the last twelve months. 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 Guidewire Software 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Guidewire Software 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, Guidewire Software actually produced more free cash flow than EBIT over the last year. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Guidewire Software has net cash of US$807m, as well as more liquid assets than liabilities. The cherry on top was that in converted 4573% of that EBIT to free cash flow, bringing in US$67m. So is Guidewire Software's debt a risk? It doesn't seem so to us. We'd be very excited to see if Guidewire Software insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.