We Think Netflix (NASDAQ:NFLX) Can Stay On Top Of Its Debt

Warren Buffett famously said, '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 Netflix, Inc. (NASDAQ:NFLX) makes use of debt. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

See our latest analysis for Netflix

How Much Debt Does Netflix Carry?

The chart below, which you can click on for greater detail, shows that Netflix had US$14.5b in debt in June 2023; about the same as the year before. However, because it has a cash reserve of US$8.58b, its net debt is less, at about US$5.89b.

How Healthy Is Netflix's Balance Sheet?

The latest balance sheet data shows that Netflix had liabilities of US$8.68b due within a year, and liabilities of US$19.3b falling due after that. On the other hand, it had cash of US$8.58b and US$1.22b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$18.2b.

Since publicly traded Netflix shares are worth a very impressive total of US$198.3b, 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.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Netflix has a low net debt to EBITDA ratio of only 0.98. And its EBIT easily covers its interest expense, being 10.2 times the size. So we're pretty relaxed about its super-conservative use of debt. But the other side of the story is that Netflix saw its EBIT decline by 5.3% over the last year. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Netflix's ability to maintain a healthy balance sheet going forward. 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. Looking at the most recent three years, Netflix recorded free cash flow of 33% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Both Netflix's ability to to cover its interest expense with its EBIT and its net debt to EBITDA gave us comfort that it can handle its debt. On the other hand, its EBIT growth rate makes us a little less comfortable about its debt. When we consider all the elements mentioned above, it seems to us that Netflix is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. Over time, share prices tend to follow earnings per share, so if you're interested in Netflix, you may well want to click here to check an interactive graph of its earnings per share history.

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.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.