Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Tower Semiconductor Ltd. (NASDAQ:TSEM) makes use of debt. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
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. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
What Is Tower Semiconductor's Debt?
The image below, which you can click on for greater detail, shows that Tower Semiconductor had debt of US$164.3m at the end of March 2021, a reduction from US$283.1m over a year. But it also has US$710.0m in cash to offset that, meaning it has US$545.7m net cash.
How Strong Is Tower Semiconductor's Balance Sheet?
We can see from the most recent balance sheet that Tower Semiconductor had liabilities of US$273.6m falling due within a year, and liabilities of US$326.1m due beyond that. On the other hand, it had cash of US$710.0m and US$164.2m worth of receivables due within a year. So it actually has US$274.5m more liquid assets than total liabilities.
This short term liquidity is a sign that Tower Semiconductor could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Tower Semiconductor has more cash than debt is arguably a good indication that it can manage its debt safely.
On top of that, Tower Semiconductor grew its EBIT by 41% 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 Tower Semiconductor 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. Tower Semiconductor 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. During the last three years, Tower Semiconductor produced sturdy free cash flow equating to 51% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While it is always sensible to investigate a company's debt, in this case Tower Semiconductor has US$545.7m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 41% over the last year. So is Tower Semiconductor's debt a risk? It doesn't seem so to us. Over time, share prices tend to follow earnings per share, so if you're interested in Tower Semiconductor, you may well want to click here to check an interactive graph of its earnings per share history.
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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