David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. Importantly, KLA Corporation (NASDAQ:KLAC) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
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What Is KLA's Net Debt?
The image below, which you can click on for greater detail, shows that KLA had debt of US$5.89b at the end of June 2023, a reduction from US$6.66b over a year. On the flip side, it has US$3.24b in cash leading to net debt of about US$2.65b.
How Healthy Is KLA's Balance Sheet?
We can see from the most recent balance sheet that KLA had liabilities of US$3.74b falling due within a year, and liabilities of US$7.41b due beyond that. Offsetting these obligations, it had cash of US$3.24b as well as receivables valued at US$1.87b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$6.04b.
Since publicly traded KLA shares are worth a very impressive total of US$63.0b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
KLA's net debt is only 0.60 times its EBITDA. And its EBIT easily covers its interest expense, being 17.9 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The good news is that KLA has increased its EBIT by 9.3% over twelve months, which should ease any concerns about debt repayment. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if KLA can strengthen its balance sheet over time. 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. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, KLA generated free cash flow amounting to a very robust 82% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
Our View
The good news is that KLA's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! Looking at the bigger picture, we think KLA'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. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for KLA that you should be aware of.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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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.
About NasdaqGS:KLAC
KLA
Engages in the design, manufacture, and marketing of process control, process-enabling, and yield management solutions for the semiconductor and related electronics industries worldwide.
Adequate balance sheet with moderate growth potential.