Cerence (NASDAQ:CRNC) has a fairly healthy balance sheet

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David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. So it may be obvious that you need to take debt into account when thinking about the risk of a given stock, because too much debt can sink a business. Above all, Cerence Inc. (NASDAQ:CRNC) is in debt. But the more important question is: what risk does this debt create?

What risk does debt carry?

Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. If things go really bad, lenders can take over the business. However, a more frequent (but still costly) event is when a company has to issue shares at bargain prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business has is to look at its cash and debt together.

What is Cerence’s debt?

The graph below, which you can click on for more details, shows that Cerence had $270.8 million in debt as of March 2022; about the same as the previous year. On the other hand, he has $143.6 million in cash, resulting in a net debt of around $127.2 million.

NasdaqGS: CRNC Debt to Equity History August 3, 2022

How healthy is Cerence’s balance sheet?

Zooming in on the latest balance sheet data, we can see that Cerence had liabilities of US$156.5 million due within 12 months and liabilities of US$489.9 million due beyond. In return, it had $143.6 million in cash and $48.0 million in receivables due within 12 months. It therefore has liabilities totaling $454.7 million more than its cash and short-term receivables, combined.

Cerence has a market capitalization of $1.13 billion, so it could very likely raise funds to improve its balance sheet, should the need arise. However, it is always worth taking a close look at its ability to repay debt.

In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.

Given its net debt to EBITDA of 1.4 and interest coverage of 4.9 times, it seems to us that Cerence is probably using debt quite sensibly. We therefore recommend that you closely monitor the impact of financing costs on the business. One way for Cerence to overcome its debt would be to stop borrowing more but continue to grow EBIT by around 19%, as it did last year. There is no doubt that we learn the most about debt from the balance sheet. But future earnings, more than anything, will determine Cerence’s ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.

Finally, a business needs free cash flow to pay off its debts; book profits are not enough. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, Cerence has produced strong free cash flow equivalent to 78% of its EBIT, which is what we expected. This free cash flow puts the company in a good position to repay its debt, should it arise.

Our point of view

Fortunately, Cerence’s impressive EBIT to free cash flow conversion means it has the upper hand on its debt. And this is only the beginning of good news since its EBIT growth rate is also very encouraging. When we consider the range of factors above, it seems Cerence is quite sensible with his use of debt. While this carries some risk, it can also improve shareholder returns. There is no doubt that we learn the most about debt from the balance sheet. But at the end of the day, every business can contain risks that exist outside of the balance sheet. We have identified 2 warning signs with Cerence, and understanding them should be part of your investment process.

If you are interested in investing in companies that can generate profits without the burden of debt, then check out this free list of growing companies that have net cash on the balance sheet.

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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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