Is Enphase Energy (NASDAQ:ENPH) Using Too Much Debt?

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.' 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, Enphase Energy, Inc. (NASDAQ:ENPH) does carry debt. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.

Our analysis indicates that ENPH is potentially overvalued!

What Is Enphase Energy's Debt?

As you can see below, at the end of September 2022, Enphase Energy had US$1.29b of debt, up from US$1.03b a year ago. Click the image for more detail. However, it does have US$1.42b in cash offsetting this, leading to net cash of US$129.0m.

How Healthy Is Enphase Energy's Balance Sheet?

We can see from the most recent balance sheet that Enphase Energy had liabilities of US$550.2m falling due within a year, and liabilities of US$1.54b due beyond that. Offsetting this, it had US$1.42b in cash and US$396.6m in receivables that were due within 12 months. So it has liabilities totalling US$273.9m 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 it's very unlikely that the US$40.9b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Enphase Energy boasts net cash, so it's fair to say it does not have a heavy debt load!

On top of that, Enphase Energy grew its EBIT by 50% over the last twelve months, and that growth will make it easier to handle its debt. 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 Enphase Energy 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 company can only pay off debt with cold hard cash, not accounting profits. Enphase Energy 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 three years, Enphase Energy actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

We could understand if investors are concerned about Enphase Energy's liabilities, but we can be reassured by the fact it has has net cash of US$129.0m. The cherry on top was that in converted 141% of that EBIT to free cash flow, bringing in US$545m. So we don't think Enphase Energy'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. Be aware that Enphase Energy is showing 1 warning sign in our investment analysis , you should know about...

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.