Is Semtech (NASDAQ:SMTC) A Risky Investment?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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, Semtech Corporation (NASDAQ:SMTC) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

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. 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. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Semtech

What Is Semtech's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of October 2022 Semtech had US$455.1m of debt, an increase on US$176.2m, over one year. But it also has US$620.8m in cash to offset that, meaning it has US$165.7m net cash.

A Look At Semtech's Liabilities

The latest balance sheet data shows that Semtech had liabilities of US$140.1m due within a year, and liabilities of US$534.2m falling due after that. On the other hand, it had cash of US$620.8m and US$80.5m worth of receivables due within a year. So it actually has US$27.1m more liquid assets than total liabilities.

This state of affairs indicates that Semtech's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$1.97b company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Semtech has more cash than debt is arguably a good indication that it can manage its debt safely.

On top of that, Semtech grew its EBIT by 46% 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 Semtech 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. While Semtech has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Happily for any shareholders, Semtech 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.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Semtech has net cash of US$165.7m, as well as more liquid assets than liabilities. The cherry on top was that in converted 118% of that EBIT to free cash flow, bringing in US$166m. So we don't think Semtech's use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. We've identified 1 warning sign with Semtech , and understanding them should be part of your investment process.

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.