We Think SMART Global Holdings (NASDAQ:SGH) Can Manage Its Debt With Ease

By
Simply Wall St
Published
May 20, 2022
NasdaqGS:SGH
Source: Shutterstock

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. Importantly, SMART Global Holdings, Inc. (NASDAQ:SGH) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for SMART Global Holdings

What Is SMART Global Holdings's Debt?

You can click the graphic below for the historical numbers, but it shows that as of February 2022 SMART Global Holdings had US$490.3m of debt, an increase on US$210.8m, over one year. However, it does have US$365.8m in cash offsetting this, leading to net debt of about US$124.6m.

debt-equity-history-analysis
NasdaqGS:SGH Debt to Equity History May 20th 2022

A Look At SMART Global Holdings' Liabilities

We can see from the most recent balance sheet that SMART Global Holdings had liabilities of US$533.8m falling due within a year, and liabilities of US$619.8m due beyond that. On the other hand, it had cash of US$365.8m and US$403.5m worth of receivables due within a year. So its liabilities total US$384.3m more than the combination of its cash and short-term receivables.

This deficit isn't so bad because SMART Global Holdings is worth US$1.15b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt.

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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

SMART Global Holdings has net debt of just 0.52 times EBITDA, indicating that it is certainly not a reckless borrower. And this view is supported by the solid interest coverage, with EBIT coming in at 8.9 times the interest expense over the last year. Better yet, SMART Global Holdings grew its EBIT by 228% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. 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 SMART Global Holdings'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 we clearly need to look at whether that EBIT is leading to corresponding free cash flow. Over the last three years, SMART Global Holdings 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.

Our View

The good news is that SMART Global Holdings's demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its EBIT growth rate also supports that impression! Zooming out, SMART Global Holdings seems to use debt quite reasonably; and that gets the nod from us. 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. For example - SMART Global Holdings has 3 warning signs we think you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

Discounted cash flow calculation for every stock

Simply Wall St does a detailed discounted cash flow calculation every 6 hours for every stock on the market, so if you want to find the intrinsic value of any company just search here. It’s FREE.

Make Confident Investment Decisions

Simply Wall St's Editorial Team provides unbiased, factual reporting on global stocks using in-depth fundamental analysis.
Find out more about our editorial guidelines and team.