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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that BE Semiconductor Industries N.V. (AMS:BESI) does use debt in its business. 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. 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-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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does BE Semiconductor Industries Carry?
As you can see below, BE Semiconductor Industries had €272.2m of debt at June 2019, down from €285.2m a year prior. But on the other hand it also has €361.7m in cash, leading to a €89.5m net cash position.
How Healthy Is BE Semiconductor Industries's Balance Sheet?
The latest balance sheet data shows that BE Semiconductor Industries had liabilities of €83.0m due within a year, and liabilities of €309.6m falling due after that. On the other hand, it had cash of €361.7m and €92.5m worth of receivables due within a year. So it can boast €61.7m more liquid assets than total liabilities.
This short term liquidity is a sign that BE Semiconductor Industries could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, BE Semiconductor Industries boasts net cash, so it's fair to say it does not have a heavy debt load!
The modesty of its debt load may become crucial for BE Semiconductor Industries if management cannot prevent a repeat of the 53% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if BE Semiconductor Industries can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While BE Semiconductor Industries has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, BE Semiconductor Industries generated free cash flow amounting to a very robust 90% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
While it is always sensible to investigate a company's debt, in this case BE Semiconductor Industries has €89m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of €153m, being 90% of its EBIT. So we are not troubled with BE Semiconductor Industries's debt use. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that BE Semiconductor Industries insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
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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