Ultra Clean Holdings (NASDAQ:UCTT) Has A Rock Solid Balance Sheet

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.' 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. Importantly, Ultra Clean Holdings, Inc. (NASDAQ:UCTT) does carry debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Ultra Clean Holdings

How Much Debt Does Ultra Clean Holdings Carry?

You can click the graphic below for the historical numbers, but it shows that as of September 2021 Ultra Clean Holdings had US$568.3m of debt, an increase on US$280.1m, over one year. However, it does have US$457.0m in cash offsetting this, leading to net debt of about US$111.3m.

How Strong Is Ultra Clean Holdings' Balance Sheet?

We can see from the most recent balance sheet that Ultra Clean Holdings had liabilities of US$411.0m falling due within a year, and liabilities of US$672.7m due beyond that. Offsetting this, it had US$457.0m in cash and US$232.5m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$394.2m.

Since publicly traded Ultra Clean Holdings shares are worth a total of US$2.25b, 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 measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

With net debt sitting at just 0.48 times EBITDA, Ultra Clean Holdings is arguably pretty conservatively geared. And it boasts interest cover of 8.4 times, which is more than adequate. On top of that, Ultra Clean Holdings grew its EBIT by 64% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Ultra Clean Holdings's ability to maintain a healthy balance sheet going forward. 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Ultra Clean Holdings recorded free cash flow worth a fulsome 91% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

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 that's just the beginning of the good news since its EBIT growth rate is also very heartening. 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. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Ultra Clean Holdings that you should be aware of before investing here.

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.