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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Palo Alto Networks, Inc. (NYSE:PANW) makes use of debt. But the real question is whether this debt is making the company risky.
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. If things get really bad, the lenders can take control of the business. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Palo Alto Networks's Debt?
You can click the graphic below for the historical numbers, but it shows that as of October 2020 Palo Alto Networks had US$3.06b of debt, an increase on US$1.45b, over one year. But on the other hand it also has US$3.22b in cash, leading to a US$156.3m net cash position.
How Healthy Is Palo Alto Networks's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Palo Alto Networks had liabilities of US$2.64b due within 12 months and liabilities of US$5.34b due beyond that. Offsetting these obligations, it had cash of US$3.22b as well as receivables valued at US$686.5m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$4.08b.
Of course, Palo Alto Networks has a titanic market capitalization of US$29.0b, so these liabilities are probably manageable. 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, Palo Alto Networks also has more cash than debt, so we're pretty confident it can manage its debt safely. 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 Palo Alto Networks'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, Palo Alto Networks reported revenue of US$3.6b, which is a gain of 19%, 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.
So How Risky Is Palo Alto Networks?
While Palo Alto Networks lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow US$1.1b. So taking that on face value, and considering the net cash situation, we don't think that the stock is too risky in the near term. Until we see some positive EBIT, we're a bit cautious of the stock, not least because of the rather modest revenue growth. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Palo Alto Networks , and understanding them should be part of your investment process.
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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