We Think PayPal Holdings (NASDAQ:PYPL) Can Manage Its Debt With Ease

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, PayPal Holdings, Inc. (NASDAQ:PYPL) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

See our latest analysis for PayPal Holdings

What Is PayPal Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 PayPal Holdings had US$8.94b of debt, an increase on US$4.96b, over one year. But on the other hand it also has US$14.2b in cash, leading to a US$5.22b net cash position.

How Healthy Is PayPal Holdings's Balance Sheet?

We can see from the most recent balance sheet that PayPal Holdings had liabilities of US$35.2b falling due within a year, and liabilities of US$11.8b due beyond that. Offsetting this, it had US$14.2b in cash and US$3.11b in receivables that were due within 12 months. So it has liabilities totalling US$29.8b more than its cash and near-term receivables, combined.

Since publicly traded PayPal Holdings shares are worth a very impressive total of US$278.5b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, PayPal Holdings also has more cash than debt, so we're pretty confident it can manage its debt safely.

Another good sign is that PayPal Holdings has been able to increase its EBIT by 24% in twelve months, making it easier to pay down debt. 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 PayPal Holdings 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. PayPal Holdings may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, PayPal Holdings actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

Although PayPal Holdings's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$5.22b. And it impressed us with free cash flow of US$5.1b, being 152% of its EBIT. So is PayPal Holdings's debt a risk? It doesn't seem so to us. When analysing debt levels, the balance sheet is the obvious place to start. 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, 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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