Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that '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. Importantly, Lumentum Holdings Inc. (NASDAQ:LITE) does carry debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth 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 Lumentum Holdings's Net Debt?
As you can see below, at the end of July 2021, Lumentum Holdings had US$1.18b of debt, up from US$1.12b a year ago. Click the image for more detail. But on the other hand it also has US$1.95b in cash, leading to a US$765.5m net cash position.
How Strong Is Lumentum Holdings' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Lumentum Holdings had liabilities of US$664.6m due within 12 months and liabilities of US$914.2m due beyond that. Offsetting this, it had US$1.95b in cash and US$216.9m in receivables that were due within 12 months. So it can boast US$584.1m 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. Simply put, the fact that Lumentum Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.
Importantly, Lumentum Holdings grew its EBIT by 32% over the last twelve months, and that growth will make it easier to handle its debt. 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 Lumentum 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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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. Happily for any shareholders, Lumentum Holdings actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
While we empathize with investors who find debt concerning, you should keep in mind that Lumentum Holdings has net cash of US$765.5m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of US$644m, being 171% of its EBIT. So we don't think Lumentum Holdings's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 4 warning signs for Lumentum Holdings you should be aware of, and 1 of them can't be ignored.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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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