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 Benchmark Electronics, Inc. (NYSE:BHE) 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Benchmark Electronics's Net Debt?
The image below, which you can click on for greater detail, shows that Benchmark Electronics had debt of US$136.8m at the end of September 2019, a reduction from US$154.2m over a year. But it also has US$348.0m in cash to offset that, meaning it has US$211.2m net cash.
How Healthy Is Benchmark Electronics's Balance Sheet?
According to the last reported balance sheet, Benchmark Electronics had liabilities of US$441.2m due within 12 months, and liabilities of US$288.7m due beyond 12 months. Offsetting this, it had US$348.0m in cash and US$509.2m in receivables that were due within 12 months. So it actually has US$127.2m more liquid assets than total liabilities.
This surplus suggests that Benchmark Electronics has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Benchmark Electronics has more cash than debt is arguably a good indication that it can manage its debt safely.
But the bad news is that Benchmark Electronics has seen its EBIT plunge 14% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. 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 Benchmark Electronics'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 Benchmark Electronics 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. During the last three years, Benchmark Electronics produced sturdy free cash flow equating to 76% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While we empathize with investors who find debt concerning, you should keep in mind that Benchmark Electronics has net cash of US$211.2m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of US$112m, being 76% of its EBIT. So we don't think Benchmark Electronics's use of debt is risky. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Benchmark Electronics insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
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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