Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from synonymous with risk.” When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. Mostly, Spotify Technology AG (NYSE:SPOT) is in debt. But the real question is whether this debt makes the business risky.
When is debt dangerous?
Debt helps a business until the business struggles to pay it back, either with new capital or with free cash flow. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business has is to look at its cash flow and debt together.
Check out our latest analysis for Spotify technology
What is Spotify Technology’s debt?
You can click on the chart below for historical numbers, but it shows that as of December 2021, Spotify Technology had €1.20 billion in debt, an increase from zero, year-over-year. However, his balance sheet shows that he holds €3.43 billion in cash, so he actually has €2.23 billion in net cash.
A Look at Spotify Technology’s Responsibilities
According to the latest published balance sheet, Spotify Technology had liabilities of €3.23 billion maturing within 12 months and liabilities of €1.83 billion maturing beyond 12 months. In return, it had 3.43 billion euros in cash and 626.0 million euros in receivables due within 12 months. Thus, its liabilities outweigh the sum of its cash and (short-term) receivables of €992.0 million.
Given that Spotify Technology has a colossal market cap of €25.2 billion, it’s hard to believe that these liabilities pose a threat. However, we think it’s worth keeping an eye on the strength of its balance sheet, as it can change over time. Despite its notable liabilities, Spotify Technology has a net cash position, so it’s fair to say that it doesn’t have a lot of debt!
Notably, Spotify Technology posted a loss in EBIT last year, but improved it to a positive EBIT of €96 million in the last twelve months. When analyzing debt levels, the balance sheet is the obvious starting point. But it’s future earnings, more than anything, that will determine Spotify Technology’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
But our last consideration is also important, because a company cannot pay off its debts with paper profits; he needs cash. Although Spotify Technology has net cash on its balance sheet, it’s still worth looking at its ability to convert earnings before interest and taxes (EBIT) to free cash flow, to help us understand how fast it’s building ( or erodes) this treasury. balance. Fortunately for all shareholders, Spotify Technology has actually produced more free cash flow than EBIT over the past year. This kind of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Abstract
We can understand that investors are worried about Spotify Technology’s liabilities, but we can take comfort in the fact that it has a net cash position of 2.23 billion euros. And he impressed us with a free cash flow of 276 million euros, or 288% of his EBIT. So we have no problem with Spotify Technology’s use of debt. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. For example, we found 1 warning sign for Spotify technology which you should be aware of before investing here.
If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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