Is Semtech (NASDAQ:SMTC) Using Debt Sensibly?

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.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Semtech Corporation (NASDAQ:SMTC) does have debt on its balance sheet. But is this debt a concern to shareholders?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out 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 2023 Semtech had US$1.37b of debt, an increase on US$455.1m, over one year. However, it does have US$146.5m in cash offsetting this, leading to net debt of about US$1.23b.

A Look At Semtech's Liabilities

We can see from the most recent balance sheet that Semtech had liabilities of US$239.0m falling due within a year, and liabilities of US$1.46b due beyond that. On the other hand, it had cash of US$146.5m and US$156.6m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$1.40b.

When you consider that this deficiency exceeds the company's US$1.07b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price. 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 Semtech 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.

In the last year Semtech wasn't profitable at an EBIT level, but managed to grow its revenue by 8.2%, to US$843m. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

Caveat Emptor

Over the last twelve months Semtech produced an earnings before interest and tax (EBIT) loss. Indeed, it lost US$74m at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. It would need to improve its operations quickly for us to be interested in it. Not least because it burned through US$161m in negative free cash flow over the last year. So suffice it to say we consider the stock to be risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Semtech has 2 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.