Stock Analysis

Enphase Energy (NASDAQ:ENPH) Seems To Use Debt Quite Sensibly

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NasdaqGM:ENPH
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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.' 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 can see that Enphase Energy, Inc. (NASDAQ:ENPH) does use debt in its business. But the real question is whether this debt is making the company risky.

What Risk Does Debt Bring?

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. 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. 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 Enphase Energy

What Is Enphase Energy's Debt?

As you can see below, at the end of March 2022, Enphase Energy had US$1.28b of debt, up from US$1.00b a year ago. Click the image for more detail. However, it also had US$1.06b in cash, and so its net debt is US$220.7m.

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NasdaqGM:ENPH Debt to Equity History July 13th 2022

How Strong Is Enphase Energy's Balance Sheet?

According to the last reported balance sheet, Enphase Energy had liabilities of US$453.8m due within 12 months, and liabilities of US$1.48b due beyond 12 months. On the other hand, it had cash of US$1.06b and US$383.2m worth of receivables due within a year. So it has liabilities totalling US$485.6m more than its cash and near-term receivables, combined.

Having regard to Enphase Energy's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the US$25.6b company is struggling for cash, we still think it's worth monitoring its balance sheet. But either way, Enphase Energy has virtually no net debt, so it's fair to say it does not have a heavy debt load!

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Looking at its net debt to EBITDA of 0.85 and interest cover of 5.6 times, it seems to us that Enphase Energy is probably using debt in a pretty reasonable way. So we'd recommend keeping a close eye on the impact financing costs are having on the business. Enphase Energy grew its EBIT by 9.1% in the last year. That's far from incredible but it is a good thing, when it comes to paying off debt. 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 Enphase Energy's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So it's worth checking how much of that EBIT is backed by free cash flow. Happily for any shareholders, Enphase Energy actually produced more free cash flow than EBIT over the last three years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

The good news is that Enphase Energy's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. And that's just the beginning of the good news since its net debt to EBITDA is also very heartening. Looking at the bigger picture, we think Enphase Energy's use of debt seems quite reasonable and we're not concerned about it. While debt does bring risk, when used wisely it can also bring a higher return on equity. 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. To that end, you should be aware of the 2 warning signs we've spotted with Enphase Energy .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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