Ultra Clean Holdings (NASDAQ:UCTT) Could Easily Take On More Debt

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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, Ultra Clean Holdings, Inc. (NASDAQ:UCTT) does carry debt. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Ultra Clean Holdings

What Is Ultra Clean Holdings's Debt?

As you can see below, at the end of June 2021, Ultra Clean Holdings had US$594.7m of debt, up from US$329.8m a year ago. Click the image for more detail. On the flip side, it has US$451.4m in cash leading to net debt of about US$143.3m.

How Strong Is Ultra Clean Holdings' Balance Sheet?

The latest balance sheet data shows that Ultra Clean Holdings had liabilities of US$355.0m due within a year, and liabilities of US$703.0m falling due after that. Offsetting these obligations, it had cash of US$451.4m as well as receivables valued at US$210.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$396.2m.

Since publicly traded Ultra Clean Holdings shares are worth a total of US$2.08b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Ultra Clean Holdings has net debt of just 0.71 times EBITDA, indicating that it is certainly not a reckless borrower. And it boasts interest cover of 8.3 times, which is more than adequate. In addition to that, we're happy to report that Ultra Clean Holdings has boosted its EBIT by 86%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Ultra Clean Holdings 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Ultra Clean 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

Happily, Ultra Clean Holdings's impressive conversion of EBIT to free cash flow implies it has the upper hand on its debt. And the good news does not stop there, as its EBIT growth rate also supports that impression! Overall, we don't think Ultra Clean Holdings is taking any bad risks, as its debt load seems modest. So we're not worried about the use of a little leverage on the balance sheet. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example - Ultra Clean Holdings has 4 warning signs we think you should be aware of.

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.
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