Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Amdocs Limited (NASDAQ:DOX) does use debt in its business. But the real question is whether this debt is making the company risky.
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. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Amdocs’s Net Debt?
As you can see below, at the end of March 2021, Amdocs had US$744.3m of debt, up from US$350.0m a year ago. Click the image for more detail. However, its balance sheet shows it holds US$1.16b in cash, so it actually has US$419.4m net cash.
How Strong Is Amdocs’ Balance Sheet?
We can see from the most recent balance sheet that Amdocs had liabilities of US$1.34b falling due within a year, and liabilities of US$1.62b due beyond that. Offsetting this, it had US$1.16b in cash and US$907.0m in receivables that were due within 12 months. So its liabilities total US$884.7m more than the combination of its cash and short-term receivables.
Since publicly traded Amdocs shares are worth a total of US$9.94b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it’s clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Amdocs also has more cash than debt, so we’re pretty confident it can manage its debt safely.
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. The balance sheet is clearly the area to focus on when you are analysing debt. 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. During the last three years, Amdocs generated free cash flow amounting to a very robust 94% of its EBIT, more than we’d expect. That puts it in a very strong position to pay down debt.
While it is always sensible to look at a company’s total liabilities, it is very reassuring that Amdocs has US$419.4m in net cash. And it impressed us with free cash flow of US$727m, being 94% of its EBIT. So we don’t think Amdocs’s use of debt is risky. There’s no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet – far from it.