Howard Marks put it nicely when he said that, rather than worrying about share price volatility, ‘The possibility of permanent loss is the risk I worry about… and every practical investor I know worries about.’ 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. We can see that Apple Inc. (NASDAQ:AAPL) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.
Check out our latest analysis for Apple
What Is Apple’s Debt?
The chart below, which you can click on for greater detail, shows that Apple had US$120.1b in debt in September 2022; about the same as the year before. However, it does have US$48.3b in cash offsetting this, leading to net debt of about US$71.8b.
How Healthy Is Apple’s Balance Sheet?
We can see from the most recent balance sheet that Apple had liabilities of US$154.0b falling due within a year, and liabilities of US$148.1b due beyond that. On the other hand, it had cash of US$48.3b and US$60.9b worth of receivables due within a year. So it has liabilities totalling US$192.8b more than its cash and near-term receivables, combined.
Of course, Apple has a titanic market capitalization of US$2.15t, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.
We measure a company’s debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Apple’s net debt is only 0.55 times its EBITDA. And its EBIT easily covers its interest expense, being 1k times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The good news is that Apple has increased its EBIT by 9.7% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Apple’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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Apple 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.
Our View
Happily, Apple’s impressive interest cover implies it has the upper hand on its debt. And that’s just the beginning of the good news since its conversion of EBIT to free cash flow is also very heartening. Looking at the bigger picture, we think Apple’s use of debt seems quite reasonable and we’re not concerned about it. After all, sensible leverage can boost returns on equity. 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. Case in point: We’ve spotted 2 warning signs for Apple you should be aware of.
Of course, if you’re the type of investor who prefers buying stocks without the burden of debt, then don’t hesitate to discover our exclusive list of net cash growth stocks, today.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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