Lumentum Holdings (NASDAQ:LITE) Seems To Use Debt Quite Sensibly

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that Lumentum Holdings Inc. (NASDAQ:LITE) does have debt on its balance sheet. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Lumentum Holdings

How Much Debt Does Lumentum Holdings Carry?

The image below, which you can click on for greater detail, shows that at April 2022 Lumentum Holdings had debt of US$1.85b, up from US$1.16b in one year. However, it does have US$2.56b in cash offsetting this, leading to net cash of US$710.4m.

A Look At Lumentum Holdings' Liabilities

Zooming in on the latest balance sheet data, we can see that Lumentum Holdings had liabilities of US$660.7m due within 12 months and liabilities of US$1.56b due beyond that. On the other hand, it had cash of US$2.56b and US$246.3m worth of receivables due within a year. So it actually has US$589.0m more liquid assets than total liabilities.

This short term liquidity is a sign that Lumentum Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Lumentum Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

Unfortunately, Lumentum Holdings's EBIT flopped 13% over the last four quarters. If that sort of decline is not arrested, then the managing its debt will be harder than selling broccoli flavoured ice-cream for a premium. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Lumentum 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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Lumentum Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Lumentum Holdings actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Lumentum Holdings has net cash of US$710.4m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of US$388m, being 168% of its EBIT. So we are not troubled with Lumentum Holdings's debt use. 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. To that end, you should be aware of the 1 warning sign we've spotted with Lumentum Holdings .

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.