Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Alpha and Omega Semiconductor Limited (NASDAQ:AOSL) does carry debt. But should shareholders be worried about its use of debt?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Alpha and Omega Semiconductor Carry?
As you can see below, at the end of June 2021, Alpha and Omega Semiconductor had US$136.0m of debt, up from US$129.9m a year ago. Click the image for more detail. But it also has US$202.4m in cash to offset that, meaning it has US$66.4m net cash.
How Strong Is Alpha and Omega Semiconductor's Balance Sheet?
The latest balance sheet data shows that Alpha and Omega Semiconductor had liabilities of US$233.2m due within a year, and liabilities of US$169.0m falling due after that. On the other hand, it had cash of US$202.4m and US$39.6m worth of receivables due within a year. So it has liabilities totalling US$160.2m more than its cash and near-term receivables, combined.
Given Alpha and Omega Semiconductor has a market capitalization of US$833.5m, it's hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Alpha and Omega Semiconductor boasts net cash, so it's fair to say it does not have a heavy debt load!
It was also good to see that despite losing money on the EBIT line last year, Alpha and Omega Semiconductor turned things around in the last 12 months, delivering and EBIT of US$64m. 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 Alpha and Omega Semiconductor'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. Alpha and Omega Semiconductor 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. Over the last year, Alpha and Omega Semiconductor recorded free cash flow worth a fulsome 87% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.
While Alpha and Omega Semiconductor does have more liabilities than liquid assets, it also has net cash of US$66.4m. And it impressed us with free cash flow of US$56m, being 87% of its EBIT. So we don't think Alpha and Omega Semiconductor's use of debt is risky. 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. For example - Alpha and Omega Semiconductor has 1 warning sign we think you should be aware of.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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Alpha and Omega Semiconductor
Alpha and Omega Semiconductor Limited designs, develops, and supplies power semiconductor products for computing, consumer electronics, communication, and industrial applications in Hong Kong, China, South Korea, the United States, and internationally.
Excellent balance sheet with solid track record.