We Think Zoom (TYO:6694) Can Stay On Top Of Its Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 note that Zoom Corporation (TYO:6694) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Zoom

What Is Zoom's Net Debt?

As you can see below, at the end of December 2020, Zoom had JP¥2.71b of debt, up from JP¥1.25b a year ago. Click the image for more detail. But on the other hand it also has JP¥2.73b in cash, leading to a JP¥20.0m net cash position.

How Healthy Is Zoom's Balance Sheet?

We can see from the most recent balance sheet that Zoom had liabilities of JP¥3.88b falling due within a year, and liabilities of JP¥1.18b due beyond that. On the other hand, it had cash of JP¥2.73b and JP¥2.04b worth of receivables due within a year. So it has liabilities totalling JP¥288.0m more than its cash and near-term receivables, combined.

Since publicly traded Zoom shares are worth a total of JP¥5.55b, 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. While it does have liabilities worth noting, Zoom also has more cash than debt, so we're pretty confident it can manage its debt safely.

Even more impressive was the fact that Zoom grew its EBIT by 160% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Zoom's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Zoom has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Considering the last three years, Zoom actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Summing up

We could understand if investors are concerned about Zoom's liabilities, but we can be reassured by the fact it has has net cash of JP¥20.0m. And it impressed us with its EBIT growth of 160% over the last year. So we are not troubled with Zoom's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Zoom has 6 warning signs (and 1 which is a bit concerning) we think you should know about.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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