Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We can see that Elmos Semiconductor AG (ETR:ELG) does use debt in its business. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Elmos Semiconductor Carry?
The image below, which you can click on for greater detail, shows that Elmos Semiconductor had debt of €40.2m at the end of March 2020, a reduction from €59.4m over a year. However, it does have €106.0m in cash offsetting this, leading to net cash of €65.8m.
A Look At Elmos Semiconductor's Liabilities
According to the last reported balance sheet, Elmos Semiconductor had liabilities of €52.8m due within 12 months, and liabilities of €51.8m due beyond 12 months. Offsetting these obligations, it had cash of €106.0m as well as receivables valued at €50.1m due within 12 months. So it actually has €51.5m more liquid assets than total liabilities.
This surplus suggests that Elmos Semiconductor has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Elmos Semiconductor has more cash than debt is arguably a good indication that it can manage its debt safely.
On the other hand, Elmos Semiconductor's EBIT dived 15%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. 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 Elmos Semiconductor 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. Elmos Semiconductor 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. Considering the last three years, Elmos Semiconductor actually recorded a cash outflow, overall. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.
While we empathize with investors who find debt concerning, you should keep in mind that Elmos Semiconductor has net cash of €65.8m, as well as more liquid assets than liabilities. So we are not troubled with Elmos Semiconductor's debt use. 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. For instance, we've identified 4 warning signs for Elmos Semiconductor that you should be aware of.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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