Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The biggest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. It’s natural to consider a company’s balance sheet when looking at its riskiness, as debt is often involved when a company fails. Like many other companies Ultra Clean Holdings, Inc. (NASDAQ:UCTT) uses debt. But the more important question is: what risk does this debt create?
Why is debt risky?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. If things go really bad, lenders can take over the business. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.
Check out our latest analysis for Ultra Clean Holdings
How much debt does Ultra Clean Holdings have?
As you can see below, Ultra Clean Holdings had US$546.3 million in debt as of July 2022, up from US$594.7 million the previous year. However, he also had $421.4 million in cash, so his net debt is $124.9 million.
How healthy is Ultra Clean Holdings’ balance sheet?
The latest balance sheet data shows Ultra Clean Holdings had liabilities of $395.4 million due within the year, and liabilities of $654.5 million due thereafter. In return, it had $421.4 million in cash and $243.8 million in receivables due within 12 months. It therefore has liabilities totaling $384.7 million more than its cash and short-term receivables, combined.
While that might sound like a lot, it’s not that bad since Ultra Clean Holdings has a market capitalization of US$1.26 billion, so it could likely bolster its balance sheet by raising capital if needed. But it is clear that it is essential to examine closely whether it can manage its debt without dilution.
In order to assess a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its earnings before interest and taxes (EBIT) divided by its expenses. interest (its interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.
Ultra Clean Holdings has net debt of just 0.41 times EBITDA, indicating that it is certainly not an imprudent borrower. And this view is supported by strong interest coverage, with EBIT amounting to 8.6 times interest expense over the past year. On top of that, we are pleased to report that Ultra Clean Holdings increased its EBIT by 63%, reducing the specter of future debt repayments. There is no doubt that we learn the most about debt from the balance sheet. But it’s future earnings, more than anything, that will determine Ultra Clean Holdings’ ability to maintain a healthy balance sheet in the future. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
Finally, a business needs free cash flow to pay off its debts; book profits are not enough. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, Ultra Clean Holdings has recorded free cash flow of 48% of its EBIT, which is lower than expected. This low cash conversion makes debt management more difficult.
Our point of view
The good news is that Ultra Clean Holdings’ demonstrated ability to increase EBIT delights us like a fluffy puppy does a toddler. And this is only the beginning of good news since its net debt to EBITDA is also very pleasing. Given all of this data, it seems to us that Ultra Clean Holdings is taking a pretty sensible approach to debt. While this carries some risk, it can also improve shareholder returns. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks reside on the balance sheet, far from it. Example: we have identified 3 warning signs for Ultra Clean Holdings you should be aware.
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.
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