Is Synopsys (NASDAQ:SNPS) Using Too Much Debt?

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.' 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, Synopsys, Inc. (NASDAQ:SNPS) does carry debt. But should shareholders be worried about its use of debt?

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. 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. 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.

View our latest analysis for Synopsys

How Much Debt Does Synopsys Carry?

The image below, which you can click on for greater detail, shows that Synopsys had debt of US$127.9m at the end of October 2020, a reduction from US$137.7m over a year. However, its balance sheet shows it holds US$1.24b in cash, so it actually has US$1.11b net cash.

A Look At Synopsys' Liabilities

According to the last reported balance sheet, Synopsys had liabilities of US$2.14b due within 12 months, and liabilities of US$977.8m due beyond 12 months. On the other hand, it had cash of US$1.24b and US$1.03b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$854.4m.

Given Synopsys has a humongous market capitalization of US$41.8b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Synopsys also has more cash than debt, so we're pretty confident it can manage its debt safely.

Also good is that Synopsys grew its EBIT at 20% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Synopsys's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Synopsys 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, Synopsys 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.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Synopsys has US$1.11b in net cash. And it impressed us with free cash flow of US$833m, being 109% of its EBIT. So we don't think Synopsys's use of debt is risky. 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. For example - Synopsys has 1 warning sign we think you should be aware of.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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