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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Semtech Corporation (NASDAQ:SMTC) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Semtech's Net Debt?
As you can see below, Semtech had US$176.2m of debt at October 2021, down from US$184.9m a year prior. But it also has US$287.1m in cash to offset that, meaning it has US$110.9m net cash.
How Healthy Is Semtech's Balance Sheet?
The latest balance sheet data shows that Semtech had liabilities of US$123.9m due within a year, and liabilities of US$279.0m falling due after that. Offsetting this, it had US$287.1m in cash and US$74.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$41.5m.
Having regard to Semtech's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the US$4.50b company is struggling for cash, we still think it's worth monitoring its balance sheet. Despite its noteworthy liabilities, Semtech boasts net cash, so it's fair to say it does not have a heavy debt load!
On top of that, Semtech grew its EBIT by 81% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. 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.
Finally, while the tax-man may adore accounting profits, lenders only accept 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.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Semtech has US$110.9m in net cash. And it impressed us with free cash flow of US$150m, being 138% of its EBIT. So we don't think Semtech's use of debt is risky. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Semtech 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.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.