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Health Check: How Prudently Does Cloudflare (NYSE:NET) Use Debt?

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Simply Wall St
·4 min read
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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 Cloudflare, Inc. (NYSE:NET) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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, 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. 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 Cloudflare

What Is Cloudflare's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Cloudflare had US$383.3m of debt, an increase on none, over one year. But on the other hand it also has US$1.04b in cash, leading to a US$653.1m net cash position.

debt-equity-history-analysis
debt-equity-history-analysis

A Look At Cloudflare's Liabilities

We can see from the most recent balance sheet that Cloudflare had liabilities of US$141.4m falling due within a year, and liabilities of US$422.3m due beyond that. Offsetting these obligations, it had cash of US$1.04b as well as receivables valued at US$67.0m due within 12 months. So it can boast US$539.7m more liquid assets than total liabilities.

This short term liquidity is a sign that Cloudflare could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Cloudflare 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 ultimately the future profitability of the business will decide if Cloudflare 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.

In the last year Cloudflare wasn't profitable at an EBIT level, but managed to grow its revenue by 50%, to US$431m. With any luck the company will be able to grow its way to profitability.

So How Risky Is Cloudflare?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And we do note that Cloudflare had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of US$92m and booked a US$119m accounting loss. But the saving grace is the US$653.1m on the balance sheet. That means it could keep spending at its current rate for more than two years. With very solid revenue growth in the last year, Cloudflare may be on a path to profitability. By investing before those profits, shareholders take on more risk in the hope of bigger rewards. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Cloudflare has 2 warning signs we think you should be aware of.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.