Is Cisco Systems (NASDAQ:CSCO) Using Too Much Debt?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 can see that Cisco Systems, Inc. (NASDAQ:CSCO) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

Our analysis indicates that CSCO is potentially undervalued!

What Is Cisco Systems's Debt?

As you can see below, Cisco Systems had US$9.52b of debt at July 2022, down from US$11.5b a year prior. But it also has US$19.3b in cash to offset that, meaning it has US$9.75b net cash.

How Strong Is Cisco Systems' Balance Sheet?

According to the last reported balance sheet, Cisco Systems had liabilities of US$25.6b due within 12 months, and liabilities of US$28.6b due beyond 12 months. Offsetting these obligations, it had cash of US$19.3b as well as receivables valued at US$10.5b due within 12 months. So its liabilities total US$24.4b more than the combination of its cash and short-term receivables.

Since publicly traded Cisco Systems shares are worth a very impressive total of US$182.1b, it seems unlikely that this level of liabilities would be a major threat. 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, Cisco Systems also has more cash than debt, so we're pretty confident it can manage its debt safely.

Cisco Systems's EBIT was pretty flat over the last year, but that shouldn't be an issue given the it doesn't have a lot of debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Cisco Systems'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. While Cisco Systems has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Cisco Systems actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While Cisco Systems does have more liabilities than liquid assets, it also has net cash of US$9.75b. And it impressed us with free cash flow of US$13b, being 101% of its EBIT. So is Cisco Systems's debt a risk? It doesn't seem so to us. Given Cisco Systems has a strong balance sheet is profitable and pays a dividend, it would be good to know how fast its dividends are growing, if at all. You can find out instantly by clicking this link.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.