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.’ 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. Importantly, Lattice Semiconductor Corporation (NASDAQ:LSCC) does carry debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. 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 Lattice Semiconductor Carry?
You can click the graphic below for the historical numbers, but it shows that Lattice Semiconductor had US$162.2m of debt in October 2021, down from US$170.6m, one year before. But on the other hand it also has US$181.5m in cash, leading to a US$19.2m net cash position.
How Strong Is Lattice Semiconductor’s Balance Sheet?
The latest balance sheet data shows that Lattice Semiconductor had liabilities of US$103.4m due within a year, and liabilities of US$208.6m falling due after that. Offsetting this, it had US$181.5m in cash and US$84.8m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$45.7m.
Having regard to Lattice Semiconductor’s size, it seems that its liquid assets are well balanced with its total liabilities. So while it’s hard to imagine that the US$11.5b company is struggling for cash, we still think it’s worth monitoring its balance sheet. While it does have liabilities worth noting, Lattice Semiconductor also has more cash than debt, so we’re pretty confident it can manage its debt safely.
On top of that, Lattice Semiconductor grew its EBIT by 62% over the last twelve months, and that growth will make it easier to handle its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Lattice Semiconductor 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. Lattice 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. Happily for any shareholders, Lattice Semiconductor actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
Summing up
While it is always sensible to look at a company’s total liabilities, it is very reassuring that Lattice Semiconductor has US$19.2m in net cash. The cherry on top was that in converted 151% of that EBIT to free cash flow, bringing in US$118m. So we don’t think Lattice Semiconductor’s use of debt is risky. When analysing debt levels, the balance sheet is the obvious place to start.