Stock Analysis
David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. We note that SolarWinds Corporation (NYSE:SWI) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
See our latest analysis for SolarWinds
How Much Debt Does SolarWinds Carry?
The chart below, which you can click on for greater detail, shows that SolarWinds had US$1.21b in debt in March 2024; about the same as the year before. However, it also had US$312.8m in cash, and so its net debt is US$892.3m.
How Healthy Is SolarWinds' Balance Sheet?
The latest balance sheet data shows that SolarWinds had liabilities of US$625.8m due within a year, and liabilities of US$1.33b falling due after that. On the other hand, it had cash of US$312.8m and US$103.4m worth of receivables due within a year. So it has liabilities totalling US$1.54b more than its cash and near-term receivables, combined.
This is a mountain of leverage relative to its market capitalization of US$1.99b. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
While SolarWinds's debt to EBITDA ratio (3.6) suggests that it uses some debt, its interest cover is very weak, at 1.7, suggesting high leverage. It seems clear that the cost of borrowing money is negatively impacting returns for shareholders, of late. The good news is that SolarWinds grew its EBIT a smooth 53% over the last twelve months. Like the milk of human kindness that sort of growth increases resilience, making the company more capable of managing debt. 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 SolarWinds 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.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, SolarWinds actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Our View
Both SolarWinds's ability to to convert EBIT to free cash flow and its EBIT growth rate gave us comfort that it can handle its debt. In contrast, our confidence was undermined by its apparent struggle to cover its interest expense with its EBIT. When we consider all the elements mentioned above, it seems to us that SolarWinds is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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. Be aware that SolarWinds is showing 3 warning signs in our investment analysis , and 1 of those is potentially serious...
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.
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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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com
About NYSE:SWI
SolarWinds
Provides information technology (IT) management software products in the United States and internationally.