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. Importantly, AudioCodes Ltd. (NASDAQ:AUDC) does carry debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company’s use of debt, we first look at cash and debt together.
How Much Debt Does AudioCodes Carry?
You can click the graphic below for the historical numbers, but it shows that AudioCodes had US$4.93m of debt in June 2019, down from US$7.45m, one year before. However, its balance sheet shows it holds US$67.8m in cash, so it actually has US$62.9m net cash.
A Look At AudioCodes’s Liabilities
According to the last reported balance sheet, AudioCodes had liabilities of US$74.2m due within 12 months, and liabilities of US$56.0m due beyond 12 months. Offsetting this, it had US$67.8m in cash and US$30.4m in receivables that were due within 12 months. So its liabilities total US$31.9m more than the combination of its cash and short-term receivables.
Given AudioCodes has a market capitalization of US$512.9m, it’s hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, AudioCodes boasts net cash, so it’s fair to say it does not have a heavy debt load!
On top of that, AudioCodes grew its EBIT by 69% over the last twelve months, and that growth will make it easier to handle its debt. 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 AudioCodes’s ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. AudioCodes 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. Happily for any shareholders, AudioCodes actually produced more free cash flow than EBIT over the last three years. There’s nothing better than incoming cash when it comes to staying in your lenders’ good graces.
While it is always sensible to look at a company’s total liabilities, it is very reassuring that AudioCodes has US$63m in net cash. The cherry on top was that in converted 162% of that EBIT to free cash flow, bringing in US$30m. So is AudioCodes’s debt a risk? It doesn’t seem so to us. Over time, share prices tend to follow earnings per share, so if you’re interested in AudioCodes, you may well want to click here to check an interactive graph of its earnings per share history.
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.
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