Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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 ASML Holding N.V. (AMS:ASML) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 think about a company's use of debt, we first look at cash and debt together.
What Is ASML Holding's Net Debt?
The image below, which you can click on for greater detail, shows that at June 2020 ASML Holding had debt of €4.41b, up from €3.13b in one year. But on the other hand it also has €4.44b in cash, leading to a €34.2m net cash position.
A Look At ASML Holding's Liabilities
We can see from the most recent balance sheet that ASML Holding had liabilities of €4.63b falling due within a year, and liabilities of €6.98b due beyond that. Offsetting this, it had €4.44b in cash and €3.46b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €3.70b.
Since publicly traded ASML Holding shares are worth a very impressive total of €129.0b, it seems unlikely that this level of liabilities would be a major threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, ASML Holding also has more cash than debt, so we're pretty confident it can manage its debt safely.
On top of that, ASML Holding grew its EBIT by 34% over the last twelve months, and that growth will make it easier to handle its debt. 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 ASML Holding'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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. ASML Holding 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. During the last three years, ASML Holding produced sturdy free cash flow equating to 63% 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.
We could understand if investors are concerned about ASML Holding's liabilities, but we can be reassured by the fact it has has net cash of €34.2m. And we liked the look of last year's 34% year-on-year EBIT growth. So we don't think ASML Holding's use of debt is risky. We'd be very excited to see if ASML Holding 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.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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