Here's Why Ciena (NYSE:CIEN) Can Manage Its Debt Responsibly

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 Ciena Corporation (NYSE:CIEN) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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.

Check out our latest analysis for Ciena

What Is Ciena's Debt?

You can click the graphic below for the historical numbers, but it shows that as of October 2022 Ciena had US$1.07b of debt, an increase on US$693.2m, over one year. But it also has US$1.15b in cash to offset that, meaning it has US$80.3m net cash.

A Look At Ciena's Liabilities

According to the last reported balance sheet, Ciena had liabilities of US$1.04b due within 12 months, and liabilities of US$1.32b due beyond 12 months. On the other hand, it had cash of US$1.15b and US$1.10b worth of receivables due within a year. So its liabilities total US$107.6m more than the combination of its cash and short-term receivables.

Having regard to Ciena's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the US$7.32b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Ciena boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Ciena if management cannot prevent a repeat of the 47% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Ciena'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, while the tax-man may adore accounting profits, lenders only accept 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. Looking at the most recent three years, Ciena recorded free cash flow of 49% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

We could understand if investors are concerned about Ciena's liabilities, but we can be reassured by the fact it has has net cash of US$80.3m. So we don't have any problem with Ciena's use of debt. 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. For instance, we've identified 1 warning sign for Ciena that you should be aware of.

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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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.