David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 note that Sonos, Inc. (NASDAQ:SONO) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Sonos Carry?
You can click the graphic below for the historical numbers, but it shows that as of September 2019 Sonos had US$33.2m of debt, an increase on US$39.8, over one year. But on the other hand it also has US$338.6m in cash, leading to a US$305.5m net cash position.
A Look At Sonos's Liabilities
According to the last reported balance sheet, Sonos had liabilities of US$402.5m due within 12 months, and liabilities of US$78.2m due beyond 12 months. Offsetting this, it had US$338.6m in cash and US$102.7m in receivables that were due within 12 months. So it has liabilities totalling US$39.3m more than its cash and near-term receivables, combined.
Of course, Sonos has a market capitalization of US$1.65b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Sonos also has more cash than debt, so we're pretty confident it can manage its debt safely.
Although Sonos made a loss at the EBIT level, last year, it was also good to see that it generated US$5.7m in EBIT over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Sonos's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Sonos 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. Over the last year, Sonos actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
We could understand if investors are concerned about Sonos's liabilities, but we can be reassured by the fact it has has net cash of US$305.5m. And it impressed us with free cash flow of US$97m, being 1709% of its EBIT. So is Sonos's debt a risk? It doesn't seem so to us. 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. Take risks, for example - Sonos has 1 warning sign we think 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.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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