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’. It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Apple Inc. (NASDAQ:AAPL) makes use of debt. But the more important question is: how much risk is that debt creating?
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. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Apple’s Debt?
The image below, which you can click on for greater detail, shows that at September 2019 Apple had debt of US$108.0b, up from US$114.5k in one year. However, because it has a cash reserve of US$100.6b, its net debt is less, at about US$7.49b.
How Strong Is Apple’s Balance Sheet?
The latest balance sheet data shows that Apple had liabilities of US$105.7b due within a year, and liabilities of US$142.3b falling due after that. Offsetting this, it had US$100.6b in cash and US$45.8b in receivables that were due within 12 months. So it has liabilities totalling US$101.7b more than its cash and near-term receivables, combined.
Since publicly traded Apple shares are worth a very impressive total of US$1.24t, 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. But either way, Apple has virtually no net debt, so it’s fair to say it does not have a heavy debt load!
We measure a company’s debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Apple has barely any net debt, as demonstrated by its net debt to EBITDA ratio of only 0.098. Happily, it actually managed to receive more interest than it paid, over the last year. So it’s fair to say it can handle debt like an Olympic ice-skater handles a pirouette. On the other hand, Apple saw its EBIT drop by 9.8% in the last twelve months. That sort of decline, if sustained, will obviously make debt harder to handle. 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 Apple 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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Apple recorded free cash flow worth a fulsome 89% of its EBIT, which is stronger than we’d usually expect. That puts it in a very strong position to pay down debt.
The good news is that Apple’s demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But truth be told we feel its EBIT growth rate does undermine this impression a bit. When we consider the range of factors above, it looks like Apple is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you’ve also come to that realization, you’re in luck, because today you can view this interactive graph of Apple’s earnings per share history for free.
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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