We Think Adobe (NASDAQ:ADBE) Can Manage Its Debt With Ease

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 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. Importantly, Adobe Inc. (NASDAQ:ADBE) does carry debt. But the real question is whether this debt is making the company risky.

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. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Adobe

How Much Debt Does Adobe Carry?

The chart below, which you can click on for greater detail, shows that Adobe had US$4.11b in debt in May 2020; about the same as the year before. However, its balance sheet shows it holds US$4.35b in cash, so it actually has US$237.0m net cash.

How Strong Is Adobe's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Adobe had liabilities of US$5.16b due within 12 months and liabilities of US$5.56b due beyond that. Offsetting these obligations, it had cash of US$4.35b as well as receivables valued at US$1.37b due within 12 months. So its liabilities total US$5.0b more than the combination of its cash and short-term receivables.

Since publicly traded Adobe shares are worth a very impressive total of US$244.8b, it seems unlikely that this level of liabilities would be a major 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, Adobe boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Adobe grew its EBIT by 31% over the last twelve months, and that growth will make it easier to handle its debt. 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 Adobe can strengthen its balance sheet over time. 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. Adobe 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 three years, Adobe actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

We could understand if investors are concerned about Adobe's liabilities, but we can be reassured by the fact it has has net cash of US$237.0m. The cherry on top was that in converted 125% of that EBIT to free cash flow, bringing in US$4.4b. So we don't think Adobe's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Adobe you should be aware of.

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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