Cerence (NASDAQ:CRNC) Is Making Moderate Use Of 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. Importantly, Cerence Inc. (NASDAQ:CRNC) does carry debt. But the real question is whether this debt is making the company risky.

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Cerence

What Is Cerence's Debt?

The chart below, which you can click on for greater detail, shows that Cerence had US$279.4m in debt in June 2023; about the same as the year before. However, because it has a cash reserve of US$102.8m, its net debt is less, at about US$176.6m.

How Healthy Is Cerence's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Cerence had liabilities of US$168.4m due within 12 months and liabilities of US$440.9m due beyond that. Offsetting these obligations, it had cash of US$102.8m as well as receivables valued at US$57.0m due within 12 months. So its liabilities total US$449.6m more than the combination of its cash and short-term receivables.

This deficit is considerable relative to its market capitalization of US$748.6m, so it does suggest shareholders should keep an eye on Cerence's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Cerence can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, Cerence made a loss at the EBIT level, and saw its revenue drop to US$272m, which is a fall of 26%. That makes us nervous, to say the least.

Caveat Emptor

While Cerence's falling revenue is about as heartwarming as a wet blanket, arguably its earnings before interest and tax (EBIT) loss is even less appealing. Indeed, it lost US$37m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled US$15m in negative free cash flow over the last twelve months. So suffice it to say we do consider the stock to be risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Cerence you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.