Allegro MicroSystems (NASDAQ:ALGM) Seems To Use Debt Rather Sparingly

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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Allegro MicroSystems, Inc. (NASDAQ:ALGM) does use debt in its business. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Allegro MicroSystems

What Is Allegro MicroSystems's Net Debt?

As you can see below, Allegro MicroSystems had US$25.0m of debt, at September 2023, which is about the same as the year before. You can click the chart for greater detail. However, it does have US$370.0m in cash offsetting this, leading to net cash of US$345.0m.

How Healthy Is Allegro MicroSystems' Balance Sheet?

According to the last reported balance sheet, Allegro MicroSystems had liabilities of US$134.2m due within 12 months, and liabilities of US$52.4m due beyond 12 months. On the other hand, it had cash of US$370.0m and US$123.4m worth of receivables due within a year. So it can boast US$306.8m more liquid assets than total liabilities.

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

In addition to that, we're happy to report that Allegro MicroSystems has boosted its EBIT by 93%, thus reducing the spectre of future debt repayments. 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 Allegro MicroSystems 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. Allegro MicroSystems 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, Allegro MicroSystems produced sturdy free cash flow equating to 58% 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.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Allegro MicroSystems has net cash of US$345.0m, as well as more liquid assets than liabilities. And we liked the look of last year's 93% year-on-year EBIT growth. So we don't think Allegro MicroSystems's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example - Allegro MicroSystems has 1 warning sign we think you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.