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. As with many other companies Electronic Arts Inc. (NASDAQ:EA) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
What Is Electronic Arts's Net Debt?
The chart below, which you can click on for greater detail, shows that Electronic Arts had US$1.88b in debt in June 2022; about the same as the year before. However, it does have US$2.42b in cash offsetting this, leading to net cash of US$538.0m.
How Strong Is Electronic Arts' Balance Sheet?
We can see from the most recent balance sheet that Electronic Arts had liabilities of US$2.83b falling due within a year, and liabilities of US$2.72b due beyond that. Offsetting these obligations, it had cash of US$2.42b as well as receivables valued at US$579.0m due within 12 months. So its liabilities total US$2.56b more than the combination of its cash and short-term receivables.
Of course, Electronic Arts has a titanic market capitalization of US$36.1b, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Electronic Arts also has more cash than debt, so we're pretty confident it can manage its debt safely.
In addition to that, we're happy to report that Electronic Arts has boosted its EBIT by 42%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Electronic Arts 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Electronic Arts may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Electronic Arts actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.
We could understand if investors are concerned about Electronic Arts's liabilities, but we can be reassured by the fact it has has net cash of US$538.0m. And it impressed us with free cash flow of US$1.8b, being 131% of its EBIT. So is Electronic Arts's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in Electronic Arts, you may well want to click here to check an interactive graph of its earnings per share history.
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.
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.
Join A Paid User Research Session
You’ll receive a US$30 Amazon Gift card for 1 hour of your time while helping us build better investing tools for the individual investors like yourself. Sign up here