Alpha and Omega Semiconductor (NASDAQ:AOSL) Has A Pretty Healthy Balance Sheet

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Alpha and Omega Semiconductor Limited (NASDAQ:AOSL) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Alpha and Omega Semiconductor

How Much Debt Does Alpha and Omega Semiconductor Carry?

The image below, which you can click on for greater detail, shows that Alpha and Omega Semiconductor had debt of US$49.8m at the end of June 2023, a reduction from US$68.0m over a year. However, its balance sheet shows it holds US$195.2m in cash, so it actually has US$145.4m net cash.

How Healthy Is Alpha and Omega Semiconductor's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Alpha and Omega Semiconductor had liabilities of US$172.6m due within 12 months and liabilities of US$143.3m due beyond that. On the other hand, it had cash of US$195.2m and US$24.0m worth of receivables due within a year. So its liabilities total US$96.7m more than the combination of its cash and short-term receivables.

Of course, Alpha and Omega Semiconductor has a market capitalization of US$807.8m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Alpha and Omega Semiconductor also has more cash than debt, so we're pretty confident it can manage its debt safely.

The modesty of its debt load may become crucial for Alpha and Omega Semiconductor if management cannot prevent a repeat of the 78% cut to EBIT over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. The balance sheet is clearly the area to focus on when you are analysing debt. 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. 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. Looking at the most recent three years, Alpha and Omega Semiconductor recorded free cash flow of 25% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

Although Alpha and Omega Semiconductor's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$145.4m. So we don't have any problem with Alpha and Omega Semiconductor's use of debt. 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 instance, we've identified 1 warning sign for Alpha and Omega Semiconductor that you should be aware of.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.