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.’ 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 Amdocs Limited (NASDAQ:DOX) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Amdocs’s Debt?
The image below, which you can click on for greater detail, shows that Amdocs had debt of US$644.6m at the end of September 2021, a reduction from US$744.0m over a year. However, its balance sheet shows it holds US$965.6m in cash, so it actually has US$321.0m net cash.
How Strong Is Amdocs’ Balance Sheet?
We can see from the most recent balance sheet that Amdocs had liabilities of US$1.30b falling due within a year, and liabilities of US$1.57b due beyond that. Offsetting these obligations, it had cash of US$965.6m as well as receivables valued at US$920.7m due within 12 months. So it has liabilities totalling US$990.3m more than its cash and near-term receivables, combined.
Given Amdocs has a market capitalization of US$9.13b, it’s hard to believe these liabilities pose much threat. Having said that, it’s clear that we should continue to monitor its balance sheet, lest it change for the worse. Despite its noteworthy liabilities, Amdocs boasts net cash, so it’s fair to say it does not have a heavy debt load!
Amdocs’s EBIT was pretty flat over the last year, but that shouldn’t be an issue given the it doesn’t have a lot of 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 Amdocs can strengthen its balance sheet over time.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Amdocs 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. Over the last three years, Amdocs recorded free cash flow worth a fulsome 96% of its EBIT, which is stronger than we’d usually expect. That puts it in a very strong position to pay down debt.
While Amdocs does have more liabilities than liquid assets, it also has net cash of US$321.0m. The cherry on top was that in converted 96% of that EBIT to free cash flow, bringing in US$715m. So is Amdocs’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.