Is Ultralife (NASDAQ:ULBI) Using Too Much Debt?

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 Ultralife Corporation (NASDAQ:ULBI) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

View our latest analysis for Ultralife

What Is Ultralife's Net Debt?

As you can see below, Ultralife had US$3.73m of debt at September 2020, down from US$17.6m a year prior. However, it does have US$13.8m in cash offsetting this, leading to net cash of US$10.1m.

A Look At Ultralife's Liabilities

We can see from the most recent balance sheet that Ultralife had liabilities of US$17.4m falling due within a year, and liabilities of US$4.35m due beyond that. Offsetting this, it had US$13.8m in cash and US$15.0m in receivables that were due within 12 months. So it can boast US$7.07m more liquid assets than total liabilities.

This short term liquidity is a sign that Ultralife could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Ultralife has more cash than debt is arguably a good indication that it can manage its debt safely.

Also good is that Ultralife grew its EBIT at 11% over the last year, further increasing its ability to manage debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Ultralife's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Ultralife 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. Over the last three years, Ultralife recorded free cash flow worth a fulsome 97% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Ultralife has US$10.1m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$20m, being 97% of its EBIT. So we don't think Ultralife's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 1 warning sign for Ultralife that you should be aware of.

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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This article by Simply Wall St is general in nature. 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.
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