The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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 more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Splunk Carry?
The image below, which you can click on for greater detail, shows that at January 2022 Splunk had debt of US$3.14b, up from US$2.30b in one year. However, it does have US$1.72b in cash offsetting this, leading to net debt of about US$1.42b.
How Strong Is Splunk's Balance Sheet?
We can see from the most recent balance sheet that Splunk had liabilities of US$2.10b falling due within a year, and liabilities of US$3.47b due beyond that. On the other hand, it had cash of US$1.72b and US$1.31b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$2.55b.
Since publicly traded Splunk shares are worth a very impressive total of US$20.5b, 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. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Splunk 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.
Over 12 months, Splunk reported revenue of US$2.7b, which is a gain of 20%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
Over the last twelve months Splunk produced an earnings before interest and tax (EBIT) loss. Indeed, it lost US$1.1b at the EBIT level. 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. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of US$1.3b. So to be blunt we do think it is risky. 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. Be aware that Splunk is showing 1 warning sign in our investment analysis , you should know about...
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.
What are the risks and opportunities for Splunk?
Trading at 35.8% below our estimate of its fair value
Earnings are forecast to grow 31.56% per year
Negative shareholders equity
Shareholders have been diluted in the past year
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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.
Splunk Inc., together with its subsidiaries, provides software and cloud solutions that deliver and operationalize insights from the data generated by digital systems in the United States and internationally.
High growth potential and good value.