Does Applied Materials (NASDAQ:AMAT) Have A Healthy Balance Sheet?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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. As with many other companies Applied Materials, Inc. (NASDAQ:AMAT) makes use of debt. But is this debt a concern to shareholders?

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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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.

Our analysis indicates that AMAT is potentially undervalued!

What Is Applied Materials's Debt?

The chart below, which you can click on for greater detail, shows that Applied Materials had US$5.46b in debt in July 2022; about the same as the year before. However, it also had US$3.55b in cash, and so its net debt is US$1.91b.

How Strong Is Applied Materials' Balance Sheet?

The latest balance sheet data shows that Applied Materials had liabilities of US$6.83b due within a year, and liabilities of US$7.26b falling due after that. Offsetting this, it had US$3.55b in cash and US$5.12b in receivables that were due within 12 months. So it has liabilities totalling US$5.43b more than its cash and near-term receivables, combined.

Given Applied Materials has a humongous market capitalization of US$68.3b, it's hard to believe these liabilities pose much 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.

Applied Materials's net debt is only 0.23 times its EBITDA. And its EBIT covers its interest expense a whopping 32.9 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Also good is that Applied Materials grew its EBIT at 20% 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 future earnings, more than anything, that will determine Applied Materials'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 company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Applied Materials produced sturdy free cash flow equating to 70% 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

Applied Materials's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. And the good news does not stop there, as its net debt to EBITDA also supports that impression! Considering this range of factors, it seems to us that Applied Materials is quite prudent with its debt, and the risks seem well managed. So the balance sheet looks pretty healthy, to us. We'd be very excited to see if Applied Materials insiders have been snapping up shares. If you are too, then click on this link right now to take a (free) peek at our list of reported insider transactions.

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.