Cadence Design Systems (NASDAQ:CDNS) Could Easily Take On More Debt

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. As with many other companies Cadence Design Systems, Inc. (NASDAQ:CDNS) makes use of debt. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Cadence Design Systems

What Is Cadence Design Systems's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Cadence Design Systems had US$586.2m of debt, an increase on US$345.8m, over one year. However, its balance sheet shows it holds US$1.31b in cash, so it actually has US$720.3m net cash.

A Look At Cadence Design Systems' Liabilities

We can see from the most recent balance sheet that Cadence Design Systems had liabilities of US$1.12b falling due within a year, and liabilities of US$626.5m due beyond that. Offsetting these obligations, it had cash of US$1.31b as well as receivables valued at US$309.1m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$128.8m.

This state of affairs indicates that Cadence Design Systems' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the US$39.4b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Cadence Design Systems boasts net cash, so it's fair to say it does not have a heavy debt load!

Also good is that Cadence Design Systems grew its EBIT at 14% over the last year, further increasing its ability to manage debt. 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 Cadence Design Systems's ability to maintain a healthy balance sheet going forward. 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. While Cadence Design Systems 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. Over the last three years, Cadence Design Systems 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 Cadence Design Systems's liabilities, but we can be reassured by the fact it has has net cash of US$720.3m. The cherry on top was that in converted 137% of that EBIT to free cash flow, bringing in US$838m. So we don't think Cadence Design Systems's use of debt is risky. We'd be very excited to see if Cadence Design Systems 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.

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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