Berkshire Hathaway’s Charlie Munger-backed outside fund manager Li Lu is quick to say, “The biggest risk in investing isn’t price volatility, but whether you’re going to suffer a permanent loss of capital “. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Above all, Autodesk, Inc. (NASDAQ:ADSK) is in debt. But the more important question is: what risk does this debt create?
When is debt dangerous?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. If things go really bad, lenders can take over the business. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.
What is Autodesk Net Debt?
You can click on the chart below for historical numbers, but it shows that in October 2021 Autodesk had $2.63 billion in debt, an increase of $1.64 billion, year over year. However, since he has a cash reserve of $1.79 billion, his net debt is less, at around $834.7 million.
How healthy is Autodesk’s balance sheet?
The latest balance sheet data shows Autodesk had $3.28 billion in liabilities due within the year, and $3.97 billion in liabilities due thereafter. In return, he had $1.79 billion in cash and $580.3 million in receivables due within 12 months. Thus, its liabilities outweigh the sum of its cash and (current) receivables by $4.88 billion.
Given that Autodesk has a colossal market capitalization of $55.3 billion, it’s hard to believe that these liabilities pose a threat. That said, it is clear that we must continue to monitor its record, lest it deteriorate.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
Autodesk’s net debt is only 1.1 times its EBITDA. And its EBIT easily covers its interest charges, which is 15.2 times the size. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. On another positive note, Autodesk has increased its EBIT by 15% over the past year, further increasing its ability to manage its debt. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Autodesk can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
But our last consideration is also important, because a company cannot pay off its debts with paper profits; he needs cash. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, Autodesk has actually produced more free cash flow than EBIT. This kind of high cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Our point of view
Autodesk’s interest coverage suggests she can manage her debt as easily as Cristiano Ronaldo could score a goal against an Under-14 goalkeeper. And the good news doesn’t stop there, since its conversion of EBIT into free cash flow also confirms this impression! Overall, we think Autodesk’s use of debt seems entirely reasonable and we’re not worried about that. After all, reasonable leverage can increase return on equity. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks reside on the balance sheet, far from it. For example, we have identified 3 warning signs for Autodesk of which you should be aware.
If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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