These 4 Measures Indicate That Melexis (EBR:MELE) Is Using Debt Safely

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.' 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. As with many other companies Melexis NV (EBR:MELE) makes use of debt. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Melexis

How Much Debt Does Melexis Carry?

The image below, which you can click on for greater detail, shows that Melexis had debt of €30.0m at the end of March 2021, a reduction from €62.0m over a year. But it also has €76.9m in cash to offset that, meaning it has €46.9m net cash.

How Healthy Is Melexis' Balance Sheet?

The latest balance sheet data shows that Melexis had liabilities of €58.2m due within a year, and liabilities of €32.5m falling due after that. Offsetting this, it had €76.9m in cash and €80.0m in receivables that were due within 12 months. So it actually has €66.2m more liquid assets than total liabilities.

This state of affairs indicates that Melexis' 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 €3.57b company is struggling for cash, we still think it's worth monitoring its balance sheet. Succinctly put, Melexis boasts net cash, so it's fair to say it does not have a heavy debt load!

The good news is that Melexis has increased its EBIT by 9.1% over twelve months, which should ease any concerns about debt repayment. 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 Melexis'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Melexis 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 most recent three years, Melexis recorded free cash flow worth 67% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Melexis has net cash of €46.9m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of €80m, being 67% of its EBIT. So we don't think Melexis'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. Be aware that Melexis is showing 1 warning sign in our investment analysis , you should know about...

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.

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