Sensata Technologies Holding (NYSE:ST) Has A Somewhat Strained Balance Sheet

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. As with many other companies Sensata Technologies Holding plc (NYSE:ST) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. 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, 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Sensata Technologies Holding

How Much Debt Does Sensata Technologies Holding Carry?

You can click the graphic below for the historical numbers, but it shows that Sensata Technologies Holding had US$3.77b of debt in September 2023, down from US$4.21b, one year before. However, it also had US$889.7m in cash, and so its net debt is US$2.88b.

How Healthy Is Sensata Technologies Holding's Balance Sheet?

We can see from the most recent balance sheet that Sensata Technologies Holding had liabilities of US$872.7m falling due within a year, and liabilities of US$4.29b due beyond that. On the other hand, it had cash of US$889.7m and US$766.8m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$3.51b.

This deficit is considerable relative to its market capitalization of US$4.95b, so it does suggest shareholders should keep an eye on Sensata Technologies Holding's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Sensata Technologies Holding's debt is 3.2 times its EBITDA, and its EBIT cover its interest expense 3.9 times over. This suggests that while the debt levels are significant, we'd stop short of calling them problematic. The good news is that Sensata Technologies Holding improved its EBIT by 6.0% over the last twelve months, thus gradually reducing its debt levels relative to its earnings. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Sensata Technologies Holding can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. During the last three years, Sensata Technologies Holding produced sturdy free cash flow equating to 64% 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.

Our View

Neither Sensata Technologies Holding's ability to handle its total liabilities nor its net debt to EBITDA gave us confidence in its ability to take on more debt. But we do take some comfort from its conversion of EBIT to free cash flow. Looking at all the angles mentioned above, it does seem to us that Sensata Technologies Holding is a somewhat risky investment as a result of its debt. Not all risk is bad, as it can boost share price returns if it pays off, but this debt risk is worth keeping in mind. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Sensata Technologies Holding 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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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.