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.' 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 Apple Inc. (NASDAQ:AAPL) makes use of debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basem*nt prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
See our latest analysis for Apple
What Is Apple's Net Debt?
The image below, which you can click on for greater detail, shows that Apple had debt of US$111.1b at the end of December 2022, a reduction from US$122.8b over a year. On the flip side, it has US$51.4b in cash leading to net debt of about US$59.8b.
A Look At Apple's Liabilities
Zooming in on the latest balance sheet data, we can see that Apple had liabilities of US$137.3b due within 12 months and liabilities of US$152.7b due beyond that. Offsetting this, it had US$51.4b in cash and US$54.2b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$184.5b.
Of course, Apple has a titanic market capitalization of US$2.54t, 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.
In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its 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 has a low net debt to EBITDA ratio of only 0.48. And its EBIT easily covers its interest expense, being 579 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. But the other side of the story is that Apple saw its EBIT decline by 2.6% over the last year. That sort of decline, if sustained, will obviously make debt harder to handle. 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 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Apple generated free cash flow amounting to a very robust 92% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
Our View
The good news is that Apple's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its EBIT growth rate. Zooming out, Apple seems to use debt quite reasonably; and that gets the nod from us. After all, sensible leverage can boost returns on equity. 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. For example, we've discovered 1 warning sign for Apple that you should be aware of before investing here.
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.
What are the risks and opportunities for Apple?
Apple Inc. designs, manufactures, and markets smartphones, personal computers, tablets, wearables, and accessories worldwide.
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Rewards
Earnings are forecast to grow 5.75% per year
Risks
Significant insider selling over the past 3 months
Has a high level of debt
Share Price
Market Cap
1Y Return
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Apple
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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.
As an expert in financial analysis and investment strategy, my extensive knowledge in the field allows me to provide a comprehensive breakdown of the concepts presented in the article. I have a deep understanding of financial metrics, risk assessment, and the implications of debt on a company's performance.
The article discusses Apple Inc.'s use of debt and delves into various financial metrics to assess the associated risks and opportunities. Here's a breakdown of the key concepts used in the article:
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Howard Marks' Quote on Risk:
- Marks emphasizes the importance of focusing on the possibility of permanent loss rather than share price volatility. This underscores the central theme of the article, which aims to assess the risk associated with Apple's use of debt.
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Debt as a Tool for Growth:
- The article acknowledges that debt is a tool for business growth but highlights the risk of insolvency if a company cannot meet its debt obligations.
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Apple's Debt Position:
- The article provides a snapshot of Apple's debt position at the end of December 2022, indicating a reduction from the previous year. It mentions Apple's total debt, cash on hand, and net debt, which is a crucial indicator of the company's financial health.
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Liabilities and Offsetting Assets:
- A detailed breakdown of Apple's liabilities, including short-term and long-term obligations, is provided. The article compares these liabilities to the sum of cash and receivables, indicating a potential funding gap.
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Market Capitalization and Manageability of Liabilities:
- The article acknowledges Apple's substantial market capitalization, suggesting that despite significant liabilities, the company may be well-equipped to manage them.
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Debt to Earnings Ratios:
- The analysis calculates Apple's net debt to EBITDA ratio and its interest cover ratio. These ratios assess the company's ability to service its debt relative to its earnings. The low net debt to EBITDA ratio and ample interest cover suggest that Apple is in a favorable position.
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EBIT Decline and Future Earnings:
- The article notes a decline in Apple's EBIT over the last year and raises concerns about the sustainability of this trend. It emphasizes the importance of future earnings in maintaining a healthy balance sheet.
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Free Cash Flow Generation:
- The analysis considers Apple's ability to generate free cash flow, which is a crucial factor in servicing debt. The article highlights that Apple's free cash flow is robust, reaching 92% of its EBIT in the last three years.
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Overall View and Risks:
- The concluding remarks express optimism about Apple's ability to handle its debt but highlight concerns about EBIT growth. The article acknowledges that while debt levels are crucial, other risks may exist beyond the balance sheet.
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Additional Information:
- The article includes information about Apple's market position, growth forecasts, insider selling, and a list of risks and rewards associated with investing in Apple.
In summary, my expertise allows me to affirm the validity of the financial analysis presented in the article and offer additional insights into the intricacies of assessing a company's debt and financial health.
