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 can see that Ciena Corporation (NYSE:CIEN) does use debt in its business. But the more important question is: how much risk is that debt creating?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
What Is Ciena's Net Debt?
As you can see below, Ciena had US$708.0m of debt, at January 2021, which is about the same as the year before. You can click the chart for greater detail. But it also has US$1.18b in cash to offset that, meaning it has US$472.6m net cash.
A Look At Ciena's Liabilities
The latest balance sheet data shows that Ciena had liabilities of US$684.8m due within a year, and liabilities of US$915.6m falling due after that. Offsetting this, it had US$1.18b in cash and US$811.6m in receivables that were due within 12 months. So it actually has US$391.9m more liquid assets than total liabilities.
This surplus suggests that Ciena has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Ciena has more cash than debt is arguably a good indication that it can manage its debt safely.
Another good sign is that Ciena has been able to increase its EBIT by 26% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Ciena can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Ciena 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. During the last three years, Ciena produced sturdy free cash flow equating to 74% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
While it is always sensible to investigate a company's debt, in this case Ciena has US$472.6m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 26% over the last year. So is Ciena's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should be aware of the 1 warning sign we've spotted with Ciena .
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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