We Think VMware (NYSE:VMW) Can Stay On Top Of Its Debt

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 VMware, Inc. (NYSE:VMW) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?” data-reactid=”18″>Legendary fund manager Li Lu (who Charlie Munger backed) once said, ‘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 VMware, Inc. (NYSE:VMW) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content=" View our latest analysis for VMware ” data-reactid=”21″>View our latest analysis for VMware

What Is VMware’s Debt?

The chart below, which you can click on for greater detail, shows that VMware had US$4.25b in debt in August 2019; about the same as the year before. However, it also had US$2.95b in cash, and so its net debt is US$1.30b.

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How Healthy Is VMware’s Balance Sheet?

The latest balance sheet data shows that VMware had liabilities of US$5.86b due within a year, and liabilities of US$9.32b falling due after that. Offsetting this, it had US$2.95b in cash and US$2.30b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$9.93b.

Since publicly traded VMware shares are worth a very impressive total of US$62.8b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

We measure a company’s debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (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).

<p class="canvas-atom canvas-text Mb(1.0em) Mb(0)–sm Mt(0.8em)–sm" type="text" content="VMware's net debt is only 0.52 times its EBITDA. And its EBIT easily covers its interest expense, being 42.1 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The good news is that VMware has increased its EBIT by 9.8% over twelve months, which should ease any concerns about debt repayment. 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 VMware'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.” data-reactid=”40″>VMware’s net debt is only 0.52 times its EBITDA. And its EBIT easily covers its interest expense, being 42.1 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The good news is that VMware has increased its EBIT by 9.8% over twelve months, which should ease any concerns about debt repayment. 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 VMware’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.