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Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital”. It is only natural to consider a company’s balance sheet when looking at its level of risk, as debt is often involved when a business collapses. Above all, Adobe Inc. (NASDAQ: ADBE) is in debt. But the most important question is: what risk does this debt create?
When Is Debt a Problem?
Debt helps a business until the business struggles to repay it, either with new capital or with free cash flow. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. Of course, debt can be an important tool in businesses, especially capital intensive businesses. The first step in examining a company’s debt levels is to consider its cash flow and debt together.
See our latest analysis for Adobe
What is Adobe’s net debt?
The graph below, which you can click for more details, shows that Adobe had $ 4.12 billion in debt as of September 2021; about the same as the year before. But on the other hand, it also has $ 6.16 billion in cash, which leads to a net cash position of $ 2.04 billion.
How strong is Adobe’s balance sheet?
The latest balance sheet data shows Adobe had $ 6.19 billion in liabilities due within one year, and $ 5.54 billion in liabilities due thereafter. In return, he had $ 6.16 billion in cash and $ 1.55 billion in receivables due within 12 months. It therefore has liabilities totaling US $ 4.02 billion more than its cash and short-term receivables combined.
Considering Adobe’s size, it seems its liquid assets are well balanced with its total liabilities. So the $ 287.6 billion company is highly unlikely to run out of cash, but it’s still worth keeping an eye on the balance sheet. Despite its notable liabilities, Adobe has net cash, so it’s fair to say it doesn’t have a lot of debt!
On top of that, we are happy to report that Adobe has increased its EBIT by 38%, reducing the specter of future debt repayments. The balance sheet is clearly the area you need to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether Adobe can strengthen its balance sheet over time. So if you are focused on the future you can check out this free report showing analysts’ earnings forecasts.
But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. Adobe may have net cash on the balance sheet, but it’s always interesting to consider the extent to which the company converts its earnings before interest and taxes (EBIT) into free cash flow, as this will influence both its need and its ability to manage debt. Over the past three years, Adobe has actually generated more free cash flow than EBIT. This kind of solid money conversion makes us as excited as the crowd when the beat drops at a Daft Punk concert.
In summary
We could understand if investors are concerned about Adobe’s liabilities, but we can take comfort in the fact that it has net cash of $ 2.04 billion. The icing on the cake is that he converted 122% of that EBIT into free cash flow, bringing in US $ 6.6 billion. So we don’t think Adobe’s use of debt is risky. Another factor that would give us confidence in Adobe would be if insiders bought shares: if you are also aware of this signal, you can find out instantly by clicking on this link.
If you are interested in investing in companies that can generate profits without the burden of debt, check out this page free list of growing companies that have net cash on the balance sheet.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
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