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'. 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. We can see that F5 Networks, Inc. (NASDAQ:FFIV) does use debt in its business. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 F5 Networks's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2020 F5 Networks had US$398.0m of debt, an increase on none, over one year. However, it does have US$821.1m in cash offsetting this, leading to net cash of US$423.2m.
How Healthy Is F5 Networks's Balance Sheet?
According to the last reported balance sheet, F5 Networks had liabilities of US$1.25b due within 12 months, and liabilities of US$1.19b due beyond 12 months. Offsetting these obligations, it had cash of US$821.1m as well as receivables valued at US$439.7m due within 12 months. So it has liabilities totalling US$1.18b more than its cash and near-term receivables, combined.
Given F5 Networks has a market capitalization of US$9.07b, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, F5 Networks also has more cash than debt, so we're pretty confident it can manage its debt safely.
In fact F5 Networks's saving grace is its low debt levels, because its EBIT has tanked 27% in the last twelve months. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 F5 Networks 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 F5 Networks 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, F5 Networks actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Although F5 Networks's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$423.2m. And it impressed us with free cash flow of US$593m, being 120% of its EBIT. So we don't have any problem with F5 Networks's use of debt. 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. Case in point: We've spotted 3 warning signs for F5 Networks 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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