Is PayPal Holdings (NASDAQ:PYPL) A Risky Investment?

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.' 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 note that PayPal Holdings, Inc. (NASDAQ:PYPL) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for PayPal Holdings

How Much Debt Does PayPal Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that as of June 2022 PayPal Holdings had US$10.6b of debt, an increase on US$8.95b, over one year. On the flip side, it has US$9.31b in cash leading to net debt of about US$1.31b.

A Look At PayPal Holdings' Liabilities

The latest balance sheet data shows that PayPal Holdings had liabilities of US$45.1b due within a year, and liabilities of US$12.9b falling due after that. Offsetting these obligations, it had cash of US$9.31b as well as receivables valued at US$6.67b due within 12 months. So it has liabilities totalling US$42.1b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since PayPal Holdings has a huge market capitalization of US$108.7b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. But either way, PayPal Holdings has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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.

PayPal Holdings has a low net debt to EBITDA ratio of only 0.28. And its EBIT covers its interest expense a whopping 21.2 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. But the bad news is that PayPal Holdings has seen its EBIT plunge 13% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if PayPal Holdings 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, PayPal Holdings actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

The good news is that PayPal Holdings's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But the stark truth is that we are concerned by its EBIT growth rate. All these things considered, it appears that PayPal Holdings can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it's worth monitoring the balance sheet. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Case in point: We've spotted 3 warning signs for PayPal Holdings you should be aware of.

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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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.