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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 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. As with many other companies MagnaChip Semiconductor Corporation (NYSE:MX) makes use of debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 examine debt levels, we first consider both cash and debt levels, together.
What Is MagnaChip Semiconductor's Debt?
The chart below, which you can click on for greater detail, shows that MagnaChip Semiconductor had US$306.6m in debt in September 2020; about the same as the year before. However, its balance sheet shows it holds US$542.1m in cash, so it actually has US$235.5m net cash.
A Look At MagnaChip Semiconductor's Liabilities
According to the last reported balance sheet, MagnaChip Semiconductor had liabilities of US$419.4m due within 12 months, and liabilities of US$59.7m due beyond 12 months. Offsetting this, it had US$542.1m in cash and US$62.3m in receivables that were due within 12 months. So it can boast US$125.3m more liquid assets than total liabilities.
This excess liquidity suggests that MagnaChip Semiconductor is taking a careful approach to debt. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that MagnaChip Semiconductor has more cash than debt is arguably a good indication that it can manage its debt safely.
We saw MagnaChip Semiconductor grow its EBIT by 2.1% in the last twelve months. That's far from incredible but it is a good thing, when it comes to paying off debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if MagnaChip Semiconductor 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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. MagnaChip Semiconductor may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. During the last three years, MagnaChip Semiconductor produced sturdy free cash flow equating to 56% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.
While it is always sensible to investigate a company's debt, in this case MagnaChip Semiconductor has US$235.5m in net cash and a decent-looking balance sheet. So we don't have any problem with MagnaChip Semiconductor'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. Consider for instance, the ever-present spectre of investment risk. We've identified 2 warning signs with MagnaChip Semiconductor (at least 1 which is significant) , and understanding them should be part of your investment process.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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