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The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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. Importantly, Maxim Integrated Products, Inc. (NASDAQ:MXIM) does carry debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Maxim Integrated Products's Net Debt?
The chart below, which you can click on for greater detail, shows that Maxim Integrated Products had US$994.4m in debt in September 2020; about the same as the year before. However, it does have US$1.61b in cash offsetting this, leading to net cash of US$617.7m.
How Strong Is Maxim Integrated Products's Balance Sheet?
According to the last reported balance sheet, Maxim Integrated Products had liabilities of US$446.3m due within 12 months, and liabilities of US$1.50b due beyond 12 months. Offsetting these obligations, it had cash of US$1.61b as well as receivables valued at US$449.4m due within 12 months. So it can boast US$119.0m more liquid assets than total liabilities.
This state of affairs indicates that Maxim Integrated Products's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$22.6b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Maxim Integrated Products boasts net cash, so it's fair to say it does not have a heavy debt load!
And we also note warmly that Maxim Integrated Products grew its EBIT by 10% last year, making its debt load easier to handle. 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 Maxim Integrated Products'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Maxim Integrated Products 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. Over the last three years, Maxim Integrated Products recorded free cash flow worth a fulsome 96% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
While we empathize with investors who find debt concerning, you should keep in mind that Maxim Integrated Products has net cash of US$617.7m, as well as more liquid assets than liabilities. The cherry on top was that in converted 96% of that EBIT to free cash flow, bringing in US$763m. So is Maxim Integrated Products's debt a risk? It doesn't seem so to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Maxim Integrated Products you should be aware of.
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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