Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Universal Electronics Inc. (NASDAQ:UEIC) does carry debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Universal Electronics's Debt?
As you can see below, Universal Electronics had US$73.0m of debt at June 2020, down from US$95.0m a year prior. However, it also had US$58.8m in cash, and so its net debt is US$14.2m.
How Strong Is Universal Electronics's Balance Sheet?
According to the last reported balance sheet, Universal Electronics had liabilities of US$222.2m due within 12 months, and liabilities of US$18.0m due beyond 12 months. Offsetting this, it had US$58.8m in cash and US$152.1m in receivables that were due within 12 months. So it has liabilities totalling US$29.3m more than its cash and near-term receivables, combined.
Since publicly traded Universal Electronics shares are worth a total of US$524.0m, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Universal Electronics's net debt is only 0.22 times its EBITDA. And its EBIT covers its interest expense a whopping 12.4 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Even more impressive was the fact that Universal Electronics grew its EBIT by 219% over twelve months. That boost will make it even easier to pay down debt going forward. 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 Universal Electronics 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last two years, Universal Electronics actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
Happily, Universal Electronics's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! We think Universal Electronics is no more beholden to its lenders, than the birds are to birdwatchers. For investing nerds like us its balance sheet is almost charming. 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. Be aware that Universal Electronics is showing 2 warning signs in our investment analysis , you should know about...
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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