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. Importantly, Elastic N.V. (NYSE:ESTC) does carry debt. But should shareholders be worried about its use of debt?
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. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Elastic’s Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of July 2021 Elastic had US$565.8m of debt, an increase on none, over one year. But it also has US$993.7m in cash to offset that, meaning it has US$427.9m net cash.
A Look At Elastic’s Liabilities
The latest balance sheet data shows that Elastic had liabilities of US$434.7m due within a year, and liabilities of US$629.5m falling due after that. Offsetting this, it had US$993.7m in cash and US$110.8m in receivables that were due within 12 months. So it actually has US$40.3m more liquid assets than total liabilities.
Having regard to Elastic’s size, it seems that its liquid assets are well balanced with its total liabilities. So it’s very unlikely that the US$15.8b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Elastic has more cash than debt is arguably a good indication that it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Elastic’s ability to maintain a healthy balance sheet going forward.
In the last year Elastic wasn’t profitable at an EBIT level, but managed to grow its revenue by 44%, to US$673m. Shareholders probably have their fingers crossed that it can grow its way to profits.
So How Risky Is Elastic?
While Elastic lost money on an earnings before interest and tax (EBIT) level, it actually generated positive free cash flow US$9.1m. So taking that on face value, and considering the net cash situation, we don’t think that the stock is too risky in the near term. Keeping in mind its 44% revenue growth over the last year, we think there’s a decent chance the company is on track. We’d see further strong growth as an optimistic indication.