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Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. Importantly, Gentherm Incorporated (NASDAQ:THRM) does carry debt. But should shareholders be worried about its use of debt?
When Is Debt Dangerous?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, 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 step when considering a company's debt levels is to consider its cash and debt together.
See our latest analysis for Gentherm
How Much Debt Does Gentherm Carry?
As you can see below, Gentherm had US$38.8m of debt at March 2022, down from US$61.8m a year prior. However, its balance sheet shows it holds US$177.9m in cash, so it actually has US$139.2m net cash.
A Look At Gentherm's Liabilities
According to the last reported balance sheet, Gentherm had liabilities of US$243.7m due within 12 months, and liabilities of US$67.6m due beyond 12 months. On the other hand, it had cash of US$177.9m and US$240.8m worth of receivables due within a year. So it can boast US$107.4m more liquid assets than total liabilities.
This short term liquidity is a sign that Gentherm could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Gentherm boasts net cash, so it's fair to say it does not have a heavy debt load!
On the other hand, Gentherm's EBIT dived 20%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. 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 Gentherm can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Gentherm 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. Over the last three years, Gentherm recorded free cash flow worth a fulsome 91% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.