David Iben put it well when he said, ‘Volatility is not a risk we care about. What we care about is avoiding the 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. We can see that Entegris, Inc. (NASDAQ:ENTG) does use debt in its business. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Entegris’s Debt?
The image below, which you can click on for greater detail, shows that Entegris had debt of US$936.7m at the end of October 2021, a reduction from US$1.09b over a year. However, because it has a cash reserve of US$475.8m, its net debt is less, at about US$461.0m.
How Strong Is Entegris’ Balance Sheet?
We can see from the most recent balance sheet that Entegris had liabilities of US$309.4m falling due within a year, and liabilities of US$1.09b due beyond that. Offsetting these obligations, it had cash of US$475.8m as well as receivables valued at US$315.1m due within 12 months. So its liabilities total US$610.7m more than the combination of its cash and short-term receivables.
Given Entegris has a humongous market capitalization of US$19.9b, it’s hard to believe these liabilities pose much threat. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.
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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Entegris’s net debt is only 0.72 times its EBITDA. And its EBIT easily covers its interest expense, being 11.6 times the size. So we’re pretty relaxed about its super-conservative use of debt. In addition to that, we’re happy to report that Entegris has boosted its EBIT by 36%, thus reducing the spectre of future debt repayments. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Entegris can strengthen its balance sheet over time.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it’s worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, Entegris recorded free cash flow worth 69% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This cold hard cash means it can reduce its debt when it wants to.
Happily, Entegris’s impressive EBIT growth rate implies it has the upper hand on its debt. And the good news does not stop there, as its interest cover also supports that impression! Overall, we don’t think Entegris is taking any bad risks, as its debt load seems modest. So we’re not worried about the use of a little leverage on the balance sheet. When analysing debt levels, the balance sheet is the obvious place to start.