Stock Analysis

Is salesforce.com (NYSE:CRM) A Risky Investment?

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NYSE:CRM
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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.' 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 note that salesforce.com, inc. (NYSE:CRM) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for salesforce.com

What Is salesforce.com's Debt?

As you can see below, at the end of October 2021, salesforce.com had US$10.6b of debt, up from US$2.68b a year ago. Click the image for more detail. However, because it has a cash reserve of US$9.39b, its net debt is less, at about US$1.22b.

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NYSE:CRM Debt to Equity History February 9th 2022

How Healthy Is salesforce.com's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that salesforce.com had liabilities of US$15.0b due within 12 months and liabilities of US$15.3b due beyond that. Offsetting this, it had US$9.39b in cash and US$4.02b in receivables that were due within 12 months. So its liabilities total US$17.0b more than the combination of its cash and short-term receivables.

Since publicly traded salesforce.com shares are worth a very impressive total of US$214.2b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Carrying virtually no net debt, salesforce.com has a very light debt load indeed.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Looking at its net debt to EBITDA of 0.36 and interest cover of 5.2 times, it seems to us that salesforce.com is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Notably, salesforce.com's EBIT launched higher than Elon Musk, gaining a whopping 265% on last year. 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 salesforce.com'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. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, salesforce.com actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

The good news is that salesforce.com's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its EBIT growth rate is also very heartening. Overall, we don't think salesforce.com is taking any bad risks, as its debt load seems modest. So we're not worried about the use of a little leverage on the balance sheet. 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. We've identified 4 warning signs with salesforce.com , 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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