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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, ‘The possibility of permanent loss is the risk I worry about… and every practical investor I know worries about.’ When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Citrix Systems, Inc. (NASDAQ:CTXS) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. The first step when considering a company’s debt levels is to consider its cash and debt together.
What Is Citrix Systems’s Debt?
As you can see below, Citrix Systems had US$1.91b of debt at March 2019, down from US$2.14b a year prior. On the flip side, it has US$1.79b in cash leading to net debt of about US$119.0m.
How Healthy Is Citrix Systems’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Citrix Systems had liabilities of US$2.84b due within 12 months and liabilities of US$1.77b due beyond that. On the other hand, it had cash of US$1.79b and US$482.6m worth of receivables due within a year. So it has liabilities totalling US$2.34b more than its cash and near-term receivables, combined.
Since publicly traded Citrix Systems shares are worth a very impressive total of US$13.3b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Carrying virtually no net debt, Citrix Systems has a very light debt load indeed.
In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Citrix Systems has a low net debt to EBITDA ratio of only 0.15. And its EBIT easily covers its interest expense, being 17.6 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On the other hand, Citrix Systems saw its EBIT drop by 7.7% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Citrix Systems 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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So it’s worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Citrix Systems actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us excited like the crowd when the beat drops at a Daft Punk concert.
The good news is that Citrix Systems’s demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its EBIT growth rate. When we consider the range of factors above, it looks like Citrix Systems is pretty sensible with its use of debt. While that brings some risk, it can also enhance returns for shareholders. Over time, share prices tend to follow earnings per share, so if you’re interested in Citrix Systems, 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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If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.