Legendary fund manager Li Lu (who was backed by Charlie Munger) once said, “The biggest investment risk isn’t the volatility of prices, it’s whether you suffer a permanent loss of capital.” So it seems that smart money knows that debt – the usually play a role in bankruptcies – are a very important factor when assessing the risk of a company. Important, Electronic Arts Inc. (NASDAQ:EA) has debt. But should shareholders be worried about the use of debt?
What is the risk of debt?
Debt helps a business until the business struggles to pay it back, either with new capital or free cash flow. In the worst case, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, permanently diluting shareholders. However, the most common situation is that a company is managing its debt reasonably well — and for its own benefit. The first step in looking at a company’s debt is to look at its cash and debt together.
Check out our latest analysis for Electronic Arts
How Much Debt Does Electronic Arts Have?
The image below, which you can click for more details, shows that Electronic Arts had $1.88 billion in debt as of December 2021, up from $997.0 million in one year. But it also has $3.02 billion in cash to offset this, meaning it has $1.14 billion in net cash.
How healthy is Electronic Arts’ balance sheet?
According to its most recently reported balance sheet, Electronic Arts had $3.63 billion in debt maturing within 12 months and $2.68 billion in debt maturing after 12 months. Against these obligations, the Company had $3.02 billion in cash and $965.0 million in receivables due within 12 months. Therefore, its liabilities exceed the sum of its cash and (short-term) receivables by $2.33 billion.
With Electronic Arts’ publicly traded stock totaling a very impressive $32.4 billion, it seems unlikely that that level of liabilities would pose much of a threat. But there are enough liabilities that we would definitely recommend that shareholders keep an eye on the balance sheet going forward. Despite its notable liabilities, Electronic Arts boasts of net cash, so it’s fair to say it doesn’t have a heavy debt load!
The modest debt burden could become critical for Electronic Arts if management fails to prevent a repeat of last year’s 22 percent EBIT cut. After all, falling profits (if the trend continues) could make even modest debt quite risky. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will determine whether Electronic Arts can strengthen its balance sheet over time. So if you focus on the future, you can check this free Analyst earnings forecast report.
After all, a business needs free cash flow to pay off debt; Accounting profits just don’t cut it. Even though Electronic Arts has net cash on its balance sheet, it’s still worth taking a look at its ability to convert earnings before interest and taxes (EBIT) into free cash flow to understand how quickly it’s building (or eroding) that cash. . Balance. Electronic Arts has even generated more free cash flow than EBIT over the last three years. That kind of strong cash conversion excites us as much as the crowd does when the beat drops at a Daft Punk concert.
We could understand if investors are concerned about Electronic Arts’ debt, but rest assured the company has $1.14 billion in net cash. And it impressed us with free cash flow of $1.7 billion, which is 152% of its EBIT. So we have no problem with Electronic Arts’ use of debt. Undoubtedly, we learn most about debt from the balance sheet. But ultimately, every business can have off-balance-sheet risks. Case in point: We discovered it 1 Electronic Arts Warning Sign you should be aware of this.
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, don’t hesitate to explore our exclusive list of net cash growth stocks today.
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