David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We can see that Cloudflare, Inc. (NYSE:NET) does use debt in its business. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
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 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 step when considering a company's debt levels is to consider its cash and debt together.
What Is Cloudflare's Debt?
The image below, which you can click on for greater detail, shows that at September 2021 Cloudflare had debt of US$1.14b, up from US$374.5m in one year. However, it does have US$1.81b in cash offsetting this, leading to net cash of US$670.6m.
A Look At Cloudflare's Liabilities
The latest balance sheet data shows that Cloudflare had liabilities of US$227.0m due within a year, and liabilities of US$1.24b falling due after that. Offsetting this, it had US$1.81b in cash and US$89.8m in receivables that were due within 12 months. So it actually has US$441.3m more liquid assets than total liabilities.
Having regard to Cloudflare's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the US$42.3b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Cloudflare has more cash than debt is arguably a good indication that it can manage its debt safely. 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 Cloudflare'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.
In the last year Cloudflare wasn't profitable at an EBIT level, but managed to grow its revenue by 51%, to US$589m. With any luck the company will be able to grow its way to profitability.
So How Risky Is Cloudflare?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that Cloudflare had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of US$75m and booked a US$217m accounting loss. While this does make the company a bit risky, it's important to remember it has net cash of US$670.6m. That kitty means the company can keep spending for growth for at least two years, at current rates. With very solid revenue growth in the last year, Cloudflare may be on a path to profitability. By investing before those profits, shareholders take on more risk in the hope of bigger rewards. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Cloudflare you should know about.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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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