Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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, PayPal Holdings, Inc. (NASDAQ:PYPL) does carry debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does PayPal Holdings Carry?
You can click the graphic below for the historical numbers, but it shows that as of December 2020 PayPal Holdings had US$8.94b of debt, an increase on US$4.97b, over one year. However, its balance sheet shows it holds US$13.1b in cash, so it actually has US$4.14b net cash.
A Look At PayPal Holdings' Liabilities
According to the last reported balance sheet, PayPal Holdings had liabilities of US$38.4b due within 12 months, and liabilities of US$11.9b due beyond 12 months. Offsetting these obligations, it had cash of US$13.1b as well as receivables valued at US$3.39b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$33.8b.
Given PayPal Holdings has a humongous market capitalization of US$274.4b, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, PayPal Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!
Also positive, PayPal Holdings grew its EBIT by 23% in the last year, and that should make it easier to pay down debt, going forward. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine PayPal Holdings'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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While PayPal Holdings 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, PayPal Holdings actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
While PayPal Holdings does have more liabilities than liquid assets, it also has net cash of US$4.14b. And it impressed us with free cash flow of US$5.0b, being 154% of its EBIT. So is PayPal Holdings's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 4 warning signs for PayPal Holdings that you should be aware of.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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