Is Semtech (NASDAQ:SMTC) Using Too Much Debt?

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.' 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. We can see that Semtech Corporation (NASDAQ:SMTC) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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.

See our latest analysis for Semtech

What Is Semtech's Debt?

As you can see below, Semtech had US$171.9m of debt, at July 2022, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has US$376.1m in cash, leading to a US$204.2m net cash position.

How Strong Is Semtech's Balance Sheet?

According to the last reported balance sheet, Semtech had liabilities of US$140.1m due within 12 months, and liabilities of US$260.7m due beyond 12 months. Offsetting these obligations, it had cash of US$376.1m as well as receivables valued at US$71.1m due within 12 months. So it can boast US$46.4m more liquid assets than total liabilities.

This surplus suggests that Semtech has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Semtech boasts net cash, so it's fair to say it does not have a heavy debt load!

In addition to that, we're happy to report that Semtech has boosted its EBIT by 66%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Semtech'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Semtech may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Happily for any shareholders, Semtech actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Semtech has net cash of US$204.2m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of US$216m, being 131% of its EBIT. So is Semtech's debt a risk? It doesn't seem so to us. 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. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Semtech you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.