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. We can see that Q2 Holdings, Inc. (NYSE:QTWO) does use debt in its business. But is this debt a concern to shareholders?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 examine debt levels, we first consider both cash and debt levels, together.
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How Much Debt Does Q2 Holdings Carry?
As you can see below, at the end of September 2022, Q2 Holdings had US$668.0m of debt, up from US$544.7m a year ago. Click the image for more detail. However, it also had US$395.7m in cash, and so its net debt is US$272.3m.
How Strong Is Q2 Holdings’ Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Q2 Holdings had liabilities of US$166.2m due within 12 months and liabilities of US$736.8m due beyond that. Offsetting this, it had US$395.7m in cash and US$55.9m in receivables that were due within 12 months. So it has liabilities totalling US$451.5m more than its cash and near-term receivables, combined.
This deficit isn’t so bad because Q2 Holdings is worth US$1.88b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it’s clear that we should definitely closely examine whether it can manage its debt without dilution. 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 Q2 Holdings’s ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
In the last year Q2 Holdings wasn’t profitable at an EBIT level, but managed to grow its revenue by 16%, to US$551m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
Over the last twelve months Q2 Holdings produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at US$89m. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. We would feel better if it turned its trailing twelve month loss of US$102m into a profit. So to be blunt we do think it is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we’ve identified 1 warning sign for Q2 Holdings that you should be aware of.
At the end of the day, it’s often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It’s free.
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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.