Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ 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 can see that QUALCOMM Incorporated (NASDAQ:QCOM) does use debt in its business. But the more important question is: how much risk is that debt creating?
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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does QUALCOMM Carry?
As you can see below, QUALCOMM had US$16.4b of debt at June 2019, down from US$22.5b a year prior. However, because it has a cash reserve of US$14.4b, its net debt is less, at about US$2.07b.
How Healthy Is QUALCOMM’s Balance Sheet?
The latest balance sheet data shows that QUALCOMM had liabilities of US$10.9b due within a year, and liabilities of US$17.8b falling due after that. On the other hand, it had cash of US$14.4b and US$2.39b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$11.9b.
Of course, QUALCOMM has a titanic market capitalization of US$103.9b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
QUALCOMM’s net debt is only 0.19 times its EBITDA. And its EBIT easily covers its interest expense, being 36.3 times the size. So we’re pretty relaxed about its super-conservative use of debt. In addition to that, we’re happy to report that QUALCOMM has boosted its EBIT by 89%, thus reducing the spectre of future debt repayments. 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 QUALCOMM 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 company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. During the last three years, QUALCOMM produced sturdy free cash flow equating to 72% of its EBIT, about what we’d expect. This cold hard cash means it can reduce its debt when it wants to.
QUALCOMM’s interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14’s goalkeeper. And the good news does not stop there, as its EBIT growth rate also supports that impression! Considering this range of factors, it seems to us that QUALCOMM is quite prudent with its debt, and the risks seem well managed. So the balance sheet looks pretty healthy, to us. We’d be very excited to see if QUALCOMM insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.
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.
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