We Think Allegro MicroSystems (NASDAQ:ALGM) Can Stay On Top Of Its Debt

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.' 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. We note that Allegro MicroSystems, Inc. (NASDAQ:ALGM) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Allegro MicroSystems

What Is Allegro MicroSystems's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2024 Allegro MicroSystems had US$245.1m of debt, an increase on none, over one year. However, it also had US$212.1m in cash, and so its net debt is US$33.0m.

A Look At Allegro MicroSystems' Liabilities

Zooming in on the latest balance sheet data, we can see that Allegro MicroSystems had liabilities of US$117.9m due within 12 months and liabilities of US$281.0m due beyond that. On the other hand, it had cash of US$212.1m and US$125.2m worth of receivables due within a year. So its liabilities total US$61.6m more than the combination of its cash and short-term receivables.

This state of affairs indicates that Allegro MicroSystems' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the US$5.64b company is short on cash, but still worth keeping an eye on the balance sheet. Carrying virtually no net debt, Allegro MicroSystems has a very light debt load indeed.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Allegro MicroSystems's net debt is only 0.11 times its EBITDA. And its EBIT easily covers its interest expense, being 28.6 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The good news is that Allegro MicroSystems has increased its EBIT by 7.4% over twelve months, which should ease any concerns about debt repayment. 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 Allegro MicroSystems's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Allegro MicroSystems's free cash flow amounted to 46% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Our View

The good news is that Allegro MicroSystems's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its net debt to EBITDA also supports that impression! Taking all this data into account, it seems to us that Allegro MicroSystems takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. We'd be motivated to research the stock further if we found out that Allegro MicroSystems insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.

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. 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.

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