Stock Analysis

Here's Why Splunk (NASDAQ:SPLK) Can Afford Some Debt

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NasdaqGS:SPLK
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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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Splunk Inc. (NASDAQ:SPLK) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt A Problem?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

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What Is Splunk's Debt?

The image below, which you can click on for greater detail, shows that at July 2021 Splunk had debt of US$3.05b, up from US$2.25b in one year. On the flip side, it has US$2.50b in cash leading to net debt of about US$556.3m.

debt-equity-history-analysis
NasdaqGS:SPLK Debt to Equity History September 20th 2021

A Look At Splunk's Liabilities

We can see from the most recent balance sheet that Splunk had liabilities of US$1.54b falling due within a year, and liabilities of US$3.37b due beyond that. Offsetting these obligations, it had cash of US$2.50b as well as receivables valued at US$882.4m due within 12 months. So it has liabilities totalling US$1.53b more than its cash and near-term receivables, combined.

Of course, Splunk has a titanic market capitalization of US$24.5b, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Splunk'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.

Over 12 months, Splunk reported revenue of US$2.4b, which is a gain of 2.9%, although it did not report any earnings before interest and tax. We usually like to see faster growth from unprofitable companies, but each to their own.

Caveat Emptor

Over the last twelve months Splunk produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at US$966m. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. However, it doesn't help that it burned through US$80m of cash over the last year. So suffice it to say we do consider the stock to be risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Splunk , and understanding them should be part of your investment process.

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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