These 4 Measures Indicate That Sanmina (NASDAQ:SANM) Is Using Debt Safely

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the 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. We note that Sanmina Corporation (NASDAQ:SANM) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Sanmina

How Much Debt Does Sanmina Carry?

As you can see below, Sanmina had US$346.7m of debt, at October 2022, which is about the same as the year before. You can click the chart for greater detail. But on the other hand it also has US$529.9m in cash, leading to a US$183.1m net cash position.

How Strong Is Sanmina's Balance Sheet?

We can see from the most recent balance sheet that Sanmina had liabilities of US$2.45b falling due within a year, and liabilities of US$544.6m due beyond that. Offsetting this, it had US$529.9m in cash and US$1.64b in receivables that were due within 12 months. So its liabilities total US$825.8m more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Sanmina has a market capitalization of US$3.34b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Sanmina also has more cash than debt, so we're pretty confident it can manage its debt safely.

Another good sign is that Sanmina has been able to increase its EBIT by 26% in twelve months, making it easier to pay down 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 Sanmina'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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Sanmina 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, Sanmina recorded free cash flow worth 75% 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.

Summing Up

While Sanmina does have more liabilities than liquid assets, it also has net cash of US$183.1m. And it impressed us with free cash flow of US$192m, being 75% of its EBIT. So is Sanmina's debt a risk? It doesn't seem so to us. 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 1 warning sign for Sanmina that you should be aware of before investing here.

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.

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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.