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. We note that Semtech Corporation (NASDAQ:SMTC) does have debt on its balance sheet. But is this debt a concern to shareholders?
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. If things get really bad, the lenders can take control of the business. 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. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is Semtech's Debt?
You can click the graphic below for the historical numbers, but it shows that Semtech had US$206.6m of debt in April 2019, down from US$222.9m, one year before. However, it does have US$290.9m in cash offsetting this, leading to net cash of US$84.4m.
How Healthy Is Semtech's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Semtech had liabilities of US$103.3m due within 12 months and liabilities of US$254.9m due beyond that. Offsetting these obligations, it had cash of US$290.9m as well as receivables valued at US$66.5m due within 12 months. So its total liabilities are just about perfectly matched by its shorter-term, liquid assets.
This state of affairs indicates that Semtech's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the US$2.86b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Semtech boasts net cash, so it's fair to say it does not have a heavy debt load!
In addition to that, we're happy to report that Semtech has boosted its EBIT by 61%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Semtech's ability to maintain a healthy balance sheet going forward. 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 Semtech 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. Happily for any shareholders, Semtech actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
We could understand if investors are concerned about Semtech's liabilities, but we can be reassured by the fact it has has net cash of US$84m. And it impressed us with free cash flow of US$128m, being 137% of its EBIT. So we don't think Semtech's use of debt is risky. We'd be very excited to see if Semtech insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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