The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies EPAM Systems, Inc. (NYSE:EPAM) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does EPAM Systems Carry?
As you can see below, EPAM Systems had US$25.0m of debt, at June 2020, which is about the same as the year before. You can click the chart for greater detail. But it also has US$1.05b in cash to offset that, meaning it has US$1.03b net cash.
How Healthy Is EPAM Systems's Balance Sheet?
According to the last reported balance sheet, EPAM Systems had liabilities of US$365.6m due within 12 months, and liabilities of US$270.5m due beyond 12 months. Offsetting this, it had US$1.05b in cash and US$506.9m in receivables that were due within 12 months. So it actually has US$924.6m more liquid assets than total liabilities.
This short term liquidity is a sign that EPAM Systems could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that EPAM Systems has more cash than debt is arguably a good indication that it can manage its debt safely.
Also good is that EPAM Systems grew its EBIT at 20% over the last year, further increasing its ability to manage debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine EPAM Systems's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While EPAM Systems 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, EPAM Systems recorded free cash flow worth a fulsome 89% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
While it is always sensible to investigate a company's debt, in this case EPAM Systems has US$1.03b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$338m, being 89% of its EBIT. So is EPAM Systems's debt a risk? It doesn't seem so to us. 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. For instance, we've identified 2 warning signs for EPAM Systems that you should be aware of.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
This article by Simply Wall St is general in nature. 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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