Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. As with many other companies Maxim Integrated Products, Inc. (NASDAQ:MXIM) makes use of debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Maxim Integrated Products's Debt?
As you can see below, Maxim Integrated Products had US$992.6m of debt at June 2019, down from US$1.49b a year prior. But on the other hand it also has US$1.90b in cash, leading to a US$905.7m net cash position.
A Look At Maxim Integrated Products's Liabilities
We can see from the most recent balance sheet that Maxim Integrated Products had liabilities of US$371.2m falling due within a year, and liabilities of US$1.53b due beyond that. Offsetting this, it had US$1.90b in cash and US$360.0m in receivables that were due within 12 months. So it actually has US$359.6m more liquid assets than total liabilities.
This surplus suggests that Maxim Integrated Products has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Maxim Integrated Products boasts net cash, so it's fair to say it does not have a heavy debt load!
But the bad news is that Maxim Integrated Products has seen its EBIT plunge 11% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. 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 Maxim Integrated Products can strengthen its balance sheet over time. 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 company can only pay off debt with cold hard cash, not accounting profits. While Maxim Integrated Products 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 three years, Maxim Integrated Products recorded free cash flow worth a fulsome 98% 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 it is always sensible to investigate a company's debt, in this case Maxim Integrated Products has US$906m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$793m, being 98% of its EBIT. So we don't think Maxim Integrated Products's use of debt is risky. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Maxim Integrated Products insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.
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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