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.' 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. As with many other companies Calix, Inc. (NYSE:CALX) makes use of debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Calix's Debt?
You can click the graphic below for the historical numbers, but it shows that Calix had US$2.93m of debt in December 2020, down from US$34.0m, one year before. However, its balance sheet shows it holds US$133.8m in cash, so it actually has US$130.9m net cash.
How Healthy Is Calix's Balance Sheet?
According to the last reported balance sheet, Calix had liabilities of US$101.0m due within 12 months, and liabilities of US$46.0m due beyond 12 months. Offsetting these obligations, it had cash of US$133.8m as well as receivables valued at US$69.4m due within 12 months. So it can boast US$56.2m more liquid assets than total liabilities.
This short term liquidity is a sign that Calix could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Calix has more cash than debt is arguably a good indication that it can manage its debt safely.
Although Calix made a loss at the EBIT level, last year, it was also good to see that it generated US$45m in EBIT over the last twelve months. 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 Calix'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. While Calix 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 year, Calix recorded free cash flow worth a fulsome 97% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.
While we empathize with investors who find debt concerning, you should keep in mind that Calix has net cash of US$130.9m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of US$44m, being 97% of its EBIT. So is Calix's debt a risk? It doesn't seem so to us. 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. Be aware that Calix is showing 3 warning signs in our investment analysis , you should know about...
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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