We Think KLA (NASDAQ:KLAC) Can Manage Its Debt With Ease

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. We can see that KLA Corporation (NASDAQ:KLAC) does use debt in its business. 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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for KLA

What Is KLA's Debt?

The image below, which you can click on for greater detail, shows that at March 2022 KLA had debt of US$3.70b, up from US$3.44b in one year. However, it also had US$2.58b in cash, and so its net debt is US$1.12b.

How Strong Is KLA's Balance Sheet?

The latest balance sheet data shows that KLA had liabilities of US$2.83b due within a year, and liabilities of US$5.11b falling due after that. On the other hand, it had cash of US$2.58b and US$1.72b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$3.64b.

Since publicly traded KLA shares are worth a very impressive total of US$50.1b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

KLA has a low net debt to EBITDA ratio of only 0.30. And its EBIT easily covers its interest expense, being 23.1 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. On top of that, KLA grew its EBIT by 53% over the last twelve months, and that growth will make it easier to handle its debt. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the last three years, KLA recorded free cash flow worth a fulsome 85% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Our View

Happily, KLA's impressive interest cover implies it has the upper hand on its debt. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! It looks KLA has no trouble standing on its own two feet, and it has no reason to fear its lenders. To our minds it has a healthy happy balance sheet. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of KLA's earnings per share history for free.

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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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.