Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that ‘Volatility is far from synonymous with risk.’ It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We note that PayPal Holdings, Inc. (NASDAQ:PYPL) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for PayPal Holdings
How Much Debt Does PayPal Holdings Carry?
As you can see below, PayPal Holdings had US$8.95b of debt, at June 2021, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has US$12.4b in cash, leading to a US$3.45b net cash position.
A Look At PayPal Holdings’ Liabilities
Zooming in on the latest balance sheet data, we can see that PayPal Holdings had liabilities of US$41.3b due within 12 months and liabilities of US$11.6b due beyond that. On the other hand, it had cash of US$12.4b and US$4.02b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$36.5b.
Of course, PayPal Holdings has a titanic market capitalization of US$303.6b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, PayPal Holdings also has more cash than debt, so we’re pretty confident it can manage its debt safely.
On top of that, PayPal Holdings grew its EBIT by 45% over the last twelve months, and that growth will make it easier to handle its debt. There’s no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if PayPal Holdings can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. While PayPal Holdings has net cash on its balance sheet, it’s still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, PayPal Holdings 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.
Although PayPal Holdings’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$3.45b. The cherry on top was that in converted 171% of that EBIT to free cash flow, bringing in US$4.8b. So is PayPal Holdings’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. For example, we’ve discovered 2 warning signs for PayPal Holdings that you should be aware of before investing here.
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.
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.
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