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 IPG Photonics Corporation (NASDAQ:IPGP) does use debt in its business. But the more important question is: how much risk is that debt creating?
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. 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, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is IPG Photonics's Net Debt?
As you can see below, IPG Photonics had US$19.1m of debt at March 2021, down from US$40.8m a year prior. However, it does have US$1.44b in cash offsetting this, leading to net cash of US$1.43b.
How Healthy Is IPG Photonics' Balance Sheet?
We can see from the most recent balance sheet that IPG Photonics had liabilities of US$214.8m falling due within a year, and liabilities of US$127.5m due beyond that. On the other hand, it had cash of US$1.44b and US$260.5m worth of receivables due within a year. So it can boast US$1.36b more liquid assets than total liabilities.
This short term liquidity is a sign that IPG Photonics could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, IPG Photonics boasts net cash, so it's fair to say it does not have a heavy debt load!
And we also note warmly that IPG Photonics grew its EBIT by 17% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine IPG Photonics'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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. IPG Photonics 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. Over the most recent three years, IPG Photonics recorded free cash flow worth 63% of its EBIT, which is around normal, given free cash flow excludes interest and tax. 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 IPG Photonics has US$1.43b in net cash and a decent-looking balance sheet. And we liked the look of last year's 17% year-on-year EBIT growth. So we don't think IPG Photonics's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for IPG Photonics that 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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