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. We note that Zillow Group, Inc. (NASDAQ:ZG) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. 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. 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 step when considering a company's debt levels is to consider its cash and debt together.
What Is Zillow Group's Debt?
The chart below, which you can click on for greater detail, shows that Zillow Group had US$2.28b in debt in December 2020; about the same as the year before. However, it does have US$3.92b in cash offsetting this, leading to net cash of US$1.64b.
How Healthy Is Zillow Group's Balance Sheet?
We can see from the most recent balance sheet that Zillow Group had liabilities of US$908.6m falling due within a year, and liabilities of US$1.84b due beyond that. On the other hand, it had cash of US$3.92b and US$90.7m worth of receivables due within a year. So it actually has US$1.27b more liquid assets than total liabilities.
This short term liquidity is a sign that Zillow Group could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Zillow Group has more cash than debt is arguably a good indication that it can manage its debt safely.
Notably, Zillow Group made a loss at the EBIT level, last year, but improved that to positive EBIT of US$41m in the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Zillow Group'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. Zillow Group 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. Happily for any shareholders, Zillow Group actually produced more free cash flow than EBIT over the last year. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
While we empathize with investors who find debt concerning, you should keep in mind that Zillow Group has net cash of US$1.64b, as well as more liquid assets than liabilities. And it impressed us with free cash flow of US$316m, being 772% of its EBIT. So we don't have any problem with Zillow Group's use of debt. 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. We've identified 2 warning signs with Zillow Group , and understanding them should be part of your investment process.
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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