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We Think Fair Isaac (NYSE:FICO) Can Manage Its Debt With Ease

Simply Wall St

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.' 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. Importantly, Fair Isaac Corporation (NYSE:FICO) does carry debt. 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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Fair Isaac

How Much Debt Does Fair Isaac Carry?

As you can see below, at the end of June 2019, Fair Isaac had US$822.6m of debt, up from US$758.7m a year ago. Click the image for more detail. On the flip side, it has US$78.8m in cash leading to net debt of about US$743.8m.

NYSE:FICO Historical Debt, August 30th 2019

A Look At Fair Isaac's Liabilities

According to the last reported balance sheet, Fair Isaac had liabilities of US$457.7m due within 12 months, and liabilities of US$647.8m due beyond 12 months. Offsetting these obligations, it had cash of US$78.8m as well as receivables valued at US$318.0m due within 12 months. So its liabilities total US$708.6m more than the combination of its cash and short-term receivables.

Since publicly traded Fair Isaac shares are worth a very impressive total of US$10.2b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Fair Isaac has a debt to EBITDA ratio of 2.6 and its EBIT covered its interest expense 6.7 times. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. It is well worth noting that Fair Isaac's EBIT shot up like bamboo after rain, gaining 39% in the last twelve months. That'll make it easier to manage its debt. 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 Fair Isaac 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. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Fair Isaac generated free cash flow amounting to a very robust 92% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Our View

Fair Isaac's conversion of EBIT to free cash flow suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its net debt to EBITDA does undermine this impression a bit. Looking at the bigger picture, we think Fair Isaac's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. Another factor that would give us confidence in Fair Isaac would be if insiders have been buying shares: if you're conscious of that signal too, you can find out instantly by clicking this link.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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.