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IPG Photonics (NASDAQ:IPGP) Seems To Use Debt Quite Sensibly

Simply Wall St
·4 min read

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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 can see that IPG Photonics Corporation (NASDAQ:IPGP) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for IPG Photonics

What Is IPG Photonics's Debt?

You can click the graphic below for the historical numbers, but it shows that IPG Photonics had US$19.4m of debt in June 2020, down from US$43.6m, one year before. But it also has US$1.25b in cash to offset that, meaning it has US$1.23b net cash.

debt-equity-history-analysis
debt-equity-history-analysis

How Strong Is IPG Photonics's Balance Sheet?

We can see from the most recent balance sheet that IPG Photonics had liabilities of US$195.3m falling due within a year, and liabilities of US$126.1m due beyond that. On the other hand, it had cash of US$1.25b and US$211.9m worth of receivables due within a year. So it actually has US$1.14b more liquid assets than total liabilities.

This short term liquidity is a sign that IPG Photonics could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, IPG Photonics 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 IPG Photonics if management cannot prevent a repeat of the 45% 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 it is future earnings, more than anything, that will determine IPG Photonics'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While IPG Photonics 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. Over the most recent three years, IPG Photonics recorded free cash flow worth 58% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to investigate a company's debt, in this case IPG Photonics has US$1.23b in net cash and a decent-looking balance sheet. So we don't have any problem with IPG Photonics's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that IPG Photonics is showing 2 warning signs in our investment analysis , you should know about...

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.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.