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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Dynatrace, Inc. (NYSE:DT) does have debt on its balance sheet. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.
What Is Dynatrace's Net Debt?
You can click the graphic below for the historical numbers, but it shows that Dynatrace had US$303.4m of debt in December 2021, down from US$451.4m, one year before. But it also has US$408.7m in cash to offset that, meaning it has US$105.3m net cash.
How Healthy Is Dynatrace's Balance Sheet?
The latest balance sheet data shows that Dynatrace had liabilities of US$713.2m due within a year, and liabilities of US$408.6m falling due after that. Offsetting these obligations, it had cash of US$408.7m as well as receivables valued at US$264.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$448.7m.
Since publicly traded Dynatrace shares are worth a very impressive total of US$11.7b, 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. Despite its noteworthy liabilities, Dynatrace boasts net cash, so it's fair to say it does not have a heavy debt load!
The good news is that Dynatrace has increased its EBIT by 6.9% over twelve months, which should ease any concerns about debt repayment. 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 Dynatrace can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Dynatrace 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. Over the last two years, Dynatrace actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Dynatrace has US$105.3m in net cash. The cherry on top was that in converted 255% of that EBIT to free cash flow, bringing in US$232m. So is Dynatrace's debt a risk? It doesn't seem so to us. 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. To that end, you should be aware of the 3 warning signs we've spotted with Dynatrace .
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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.