Here's Why NetApp (NASDAQ:NTAP) Can Manage Its Debt Responsibly

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 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, NetApp, Inc. (NASDAQ:NTAP) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for NetApp

How Much Debt Does NetApp Carry?

The image below, which you can click on for greater detail, shows that at January 2021 NetApp had debt of US$2.63b, up from US$1.84b in one year. But it also has US$3.90b in cash to offset that, meaning it has US$1.27b net cash.

A Look At NetApp's Liabilities

Zooming in on the latest balance sheet data, we can see that NetApp had liabilities of US$3.05b due within 12 months and liabilities of US$5.16b due beyond that. On the other hand, it had cash of US$3.90b and US$799.0m worth of receivables due within a year. So its liabilities total US$3.51b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since NetApp has a huge market capitalization of US$17.0b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, NetApp also has more cash than debt, so we're pretty confident it can manage its debt safely.

On the other hand, NetApp saw its EBIT drop by 4.7% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. 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 NetApp'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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. NetApp 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 three years, NetApp actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

Although NetApp's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$1.27b. And it impressed us with free cash flow of US$1.0b, being 104% of its EBIT. So we are not troubled with NetApp's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with NetApp , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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This article by Simply Wall St is general in nature. 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.
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