Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, NVIDIA Corporation (NASDAQ:NVDA) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. 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. When we examine debt levels, we first consider both cash and debt levels, together.
What Is NVIDIA's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of August 2021 NVIDIA had US$11.9b of debt, an increase on US$6.96b, over one year. However, it does have US$19.7b in cash offsetting this, leading to net cash of US$7.71b.
How Healthy Is NVIDIA's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that NVIDIA had liabilities of US$4.45b due within 12 months and liabilities of US$13.1b due beyond that. On the other hand, it had cash of US$19.7b and US$3.59b worth of receivables due within a year. So it actually has US$5.74b more liquid assets than total liabilities.
This state of affairs indicates that NVIDIA's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the US$530.3b company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that NVIDIA has more cash than debt is arguably a good indication that it can manage its debt safely.
On top of that, NVIDIA grew its EBIT by 96% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if NVIDIA can strengthen its balance sheet over time. 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 NVIDIA 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, NVIDIA actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Summing up
While we empathize with investors who find debt concerning, you should keep in mind that NVIDIA has net cash of US$7.71b, as well as more liquid assets than liabilities. The cherry on top was that in converted 106% of that EBIT to free cash flow, bringing in US$6.7b. So we don't think NVIDIA's use of debt is risky. 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. Be aware that NVIDIA is showing 2 warning signs in our investment analysis , you should know about...
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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