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.’ When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Qorvo, Inc. (NASDAQ:QRVO) makes use of debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. 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.
How Much Debt Does Qorvo Carry?
As you can see below, at the end of October 2022, Qorvo had US$2.05b of debt, up from US$1.74b a year ago. Click the image for more detail. However, it does have US$911.6m in cash offsetting this, leading to net debt of about US$1.13b.
How Strong Is Qorvo’s Balance Sheet?
According to the last reported balance sheet, Qorvo had liabilities of US$764.1m due within 12 months, and liabilities of US$2.29b due beyond 12 months. Offsetting this, it had US$911.6m in cash and US$668.9m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$1.47b.
Since publicly traded Qorvo shares are worth a very impressive total of US$11.3b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it’s clear that we should continue to monitor its balance sheet, lest it change for the worse.
In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Qorvo has a low net debt to EBITDA ratio of only 0.84. And its EBIT easily covers its interest expense, being 15.0 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. The modesty of its debt load may become crucial for Qorvo if management cannot prevent a repeat of the 21% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There’s no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Qorvo’s ability to maintain a healthy balance sheet going forward.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Qorvo generated free cash flow amounting to a very robust 97% of its EBIT, more than we’d expect. That puts it in a very strong position to pay down debt.
Qorvo’s interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14’s goalkeeper. But the stark truth is that we are concerned by its EBIT growth rate. All these things considered, it appears that Qorvo can comfortably handle its current debt levels. On the plus side, this leverage can boost shareholder returns, but the potential downside is more risk of loss, so it’s worth monitoring the balance sheet.
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