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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 note that Gentherm Incorporated (NASDAQ:THRM) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Gentherm Carry?
As you can see below, at the end of September 2020, Gentherm had US$195.6m of debt, up from US$99.6m a year ago. Click the image for more detail. However, it does have US$226.5m in cash offsetting this, leading to net cash of US$31.0m.
A Look At Gentherm's Liabilities
The latest balance sheet data shows that Gentherm had liabilities of US$190.6m due within a year, and liabilities of US$219.1m falling due after that. Offsetting these obligations, it had cash of US$226.5m as well as receivables valued at US$222.7m due within 12 months. So it can boast US$39.6m more liquid assets than total liabilities.
Having regard to Gentherm's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the US$2.14b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Gentherm boasts net cash, so it's fair to say it does not have a heavy debt load!
It is just as well that Gentherm's load is not too heavy, because its EBIT was down 24% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Gentherm can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Gentherm 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, Gentherm generated free cash flow amounting to a very robust 95% 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 Gentherm has US$31.0m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$88m, being 95% of its EBIT. So we are not troubled with Gentherm's debt use. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Gentherm .
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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