Is Super Micro Computer (NASDAQ:SMCI) using too much debt?
Legendary fund manager Li Lu (whom Charlie Munger once backed) once said, “The greatest risk in investing is not price volatility, but whether you will suffer a permanent loss of capital. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. Mostly, Super Microcomputer, Inc. (NASDAQ:SMCI) is in debt. But should shareholders worry about its use of debt?
When is debt a problem?
Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case, a company can go bankrupt if it cannot pay its creditors. Although not too common, we often see companies in debt permanently diluting their shareholders because lenders force them to raise capital at a ridiculous price. By replacing dilution, however, debt can be a great tool for companies that need capital to invest in growth at high rates of return. The first step when considering a company’s debt levels is to consider its cash and debt together.
Check out our latest review for Super Micro Computer
What is Super Micro Computer’s net debt?
As you can see below, at the end of December 2021, Super Micro Computer had $315.9 million in debt, up from $45.5 million a year ago. Click on the image for more details. However, he also had $247.4 million in cash, so his net debt is $68.5 million.
A Look at Super Micro Computer’s Responsibilities
Zooming in on the latest balance sheet data, we can see that Super Micro Computer had liabilities of US$1.20 billion due within 12 months and liabilities of US$290.2 million due beyond. In return, he had $247.4 million in cash and $617.5 million in receivables due within 12 months. It therefore has liabilities totaling $624.8 million more than its cash and short-term receivables, combined.
While that might sound like a lot, it’s not too bad since Super Micro Computer has a market capitalization of US$2.14 billion, so it could probably bolster its balance sheet by raising capital if needed. But it is clear that it is essential to examine closely whether it can manage its debt without dilution.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). Thus, we consider debt to earnings with and without amortization and depreciation expense.
Super Micro Computer has net debt of just 0.41 times EBITDA, suggesting it could increase its leverage without breaking a sweat. And remarkably, although she has net debt, she has actually received more interest in the last twelve months than she has had to pay. So there’s no doubt that this company can go into debt and still be cool as a cucumber. Another good sign, Super Micro Computer was able to increase its EBIT by 24% in twelve months, thus facilitating the repayment of its debt. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether Super Micro Computer can strengthen its balance sheet over time. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.
Finally, a company can only repay its debts with cold hard cash, not with book profits. It is therefore worth checking how much of this EBIT is supported by free cash flow. Over the past three years, Super Micro Computer has actually had a cash outflow, overall. Debt is generally more expensive and almost always riskier in the hands of a company with negative free cash flow. Shareholders should hope for an improvement.
Our point of view
Super Micro Computer’s ability to cover its interest charges with its EBIT and its net debt to EBITDA has reinforced our ability to manage its debt. But truth be told, his conversion from EBIT to free cash flow had us biting our nails. Given this range of data points, we believe Super Micro Computer is in a good position to manage its level of leverage. But be warned: we believe debt levels are high enough to warrant continued monitoring. When analyzing debt levels, the balance sheet is the obvious starting point. However, not all investment risks reside on the balance sheet, far from it. Example: we have identified 1 warning sign for Super Micro Computer you should be aware.
Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.