Warren Buffett famously said, ‘Volatility is far from synonymous with risk.’ 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 Super Micro Computer, Inc. (NASDAQ:SMCI) makes use of debt. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
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. If things get really bad, the lenders can take control of the business. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest 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.
What Is Super Micro Computer’s Net Debt?
As you can see below, at the end of June 2021, Super Micro Computer had US$98.2m of debt, up from US$29.4m a year ago. Click the image for more detail. However, it does have US$232.3m in cash offsetting this, leading to net cash of US$134.1m.
A Look At Super Micro Computer’s Liabilities
The latest balance sheet data shows that Super Micro Computer had liabilities of US$968.9m due within a year, and liabilities of US$176.7m falling due after that. On the other hand, it had cash of US$232.3m and US$563.8m worth of receivables due within a year. So it has liabilities totalling US$349.5m more than its cash and near-term receivables, combined.
Since publicly traded Super Micro Computer shares are worth a total of US$1.87b, it seems unlikely that this level of liabilities would be a major threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, Super Micro Computer boasts net cash, so it’s fair to say it does not have a heavy debt load!
Another good sign is that Super Micro Computer has been able to increase its EBIT by 20% in twelve months, making it easier to pay down debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Super Micro Computer’s ability to maintain a healthy balance sheet going forward.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Super Micro Computer 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. During the last three years, Super Micro Computer produced sturdy free cash flow equating to 70% of its EBIT, about what we’d expect. This cold hard cash means it can reduce its debt when it wants to.
Although Super Micro Computer’s balance sheet isn’t particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$134.1m. And it impressed us with free cash flow of US$65m, being 70% of its EBIT. So is Super Micro Computer’s debt a risk? It doesn’t seem so to us. There’s no doubt that we learn most about debt from the balance sheet.