The external fund manager backed by Berkshire Hathaway’s Charlie Munger, Li Lu, makes no bones about it when he says ‘The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.’ So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. We note that The Trade Desk, Inc. (NASDAQ:TTD) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. 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. The first step when considering a company’s debt levels is to consider its cash and debt together.
View our latest analysis for Trade Desk
What Is Trade Desk’s Debt?
The image below, which you can click on for greater detail, shows that at June 2020 Trade Desk had debt of US$142.0m, up from none in one year. But on the other hand it also has US$555.3m in cash, leading to a US$413.3m net cash position.
A Look At Trade Desk’s Liabilities
The latest balance sheet data shows that Trade Desk had liabilities of US$730.7m due within a year, and liabilities of US$359.9m falling due after that. On the other hand, it had cash of US$555.3m and US$869.1m worth of receivables due within a year. So it can boast US$333.8m more liquid assets than total liabilities.
Having regard to Trade Desk’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$29.3b company is struggling for cash, we still think it’s worth monitoring its balance sheet. Simply put, the fact that Trade Desk has more cash than debt is arguably a good indication that it can manage its debt safely.
In fact Trade Desk’s saving grace is its low debt levels, because its EBIT has tanked 36% in the last twelve months. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Trade Desk’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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Trade Desk 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, Trade Desk recorded free cash flow worth a fulsome 87% of its EBIT, which is stronger than we’d usually expect. That positions it well to pay down debt if desirable to do so.
Summing up
While we empathize with investors who find debt concerning, you should keep in mind that Trade Desk has net cash of US$413.3m, as well as more liquid assets than liabilities. The cherry on top was that in converted 87% of that EBIT to free cash flow, bringing in US$104m. So we are not troubled with Trade Desk’s debt use. 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 2 warning signs for Trade Desk that you should be aware of before investing here.
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. 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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