Does Alpha and Omega Semiconductor (NASDAQ:AOSL) Have A Healthy Balance Sheet?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Alpha and Omega Semiconductor Limited (NASDAQ:AOSL) makes use of debt. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Alpha and Omega Semiconductor

What Is Alpha and Omega Semiconductor's Debt?

You can click the graphic below for the historical numbers, but it shows that Alpha and Omega Semiconductor had US$47.0m of debt in September 2023, down from US$73.7m, one year before. But it also has US$193.6m in cash to offset that, meaning it has US$146.6m net cash.

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

We can see from the most recent balance sheet that Alpha and Omega Semiconductor had liabilities of US$187.5m falling due within a year, and liabilities of US$133.5m due beyond that. On the other hand, it had cash of US$193.6m and US$36.8m worth of receivables due within a year. So it has liabilities totalling US$90.7m more than its cash and near-term receivables, combined.

Given Alpha and Omega Semiconductor has a market capitalization of US$651.8m, 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. 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 94% 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 ultimately the future profitability of the business will decide if Alpha and Omega Semiconductor 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. While Alpha and Omega Semiconductor has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent three years, Alpha and Omega Semiconductor recorded free cash flow of 27% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

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$146.6m. So we don't have any problem with Alpha and Omega Semiconductor's use of debt. While Alpha and Omega Semiconductor didn't make a statutory profit in the last year, its positive EBIT suggests that profitability might not be far away. Click here to see if its earnings are heading in the right direction, over the medium term.

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.