The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Palo Alto Networks, Inc. (NYSE:PANW) does use debt in its business. But is this debt a concern to shareholders?
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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Palo Alto Networks's Debt?
The image below, which you can click on for greater detail, shows that Palo Alto Networks had debt of US$1.46b at the end of January 2020, a reduction from US$1.56b over a year. However, its balance sheet shows it holds US$3.13b in cash, so it actually has US$1.67b net cash.
A Look At Palo Alto Networks's Liabilities
The latest balance sheet data shows that Palo Alto Networks had liabilities of US$2.24b due within a year, and liabilities of US$3.34b falling due after that. Offsetting these obligations, it had cash of US$3.13b as well as receivables valued at US$540.3m due within 12 months. So its liabilities total US$1.90b more than the combination of its cash and short-term receivables.
Given Palo Alto Networks has a humongous market capitalization of US$21.3b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Palo Alto Networks 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 Palo Alto Networks's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Over 12 months, Palo Alto Networks reported revenue of US$3.1b, which is a gain of 20%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.
So How Risky Is Palo Alto Networks?
Although Palo Alto Networks had negative earnings before interest and tax (EBIT) over the last twelve months, it generated positive free cash flow of US$890m. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. One positive is that Palo Alto Networks is growing revenue apace, which makes it easier to sell a growth story and raise capital if need be. But we still think it's somewhat 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. Consider risks, for instance. Every company has them, and we've spotted 3 warning signs for Palo Alto Networks you should know about.
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.
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