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. We can see that Marvell Technology, Inc. (NASDAQ:MRVL) does use debt in its business. But should shareholders be worried about its use of debt?
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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. When we examine debt levels, we first consider both cash and debt levels, together.
Check out our latest analysis for Marvell Technology
What Is Marvell Technology’s Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of May 2021 Marvell Technology had US$4.90b of debt, an increase on US$1.44b, over one year. On the flip side, it has US$572.6m in cash leading to net debt of about US$4.33b.
How Strong Is Marvell Technology’s Balance Sheet?
We can see from the most recent balance sheet that Marvell Technology had liabilities of US$1.16b falling due within a year, and liabilities of US$5.21b due beyond that. Offsetting this, it had US$572.6m in cash and US$694.4m in receivables that were due within 12 months. So it has liabilities totalling US$5.11b more than its cash and near-term receivables, combined.
Given Marvell Technology has a humongous market capitalization of US$42.7b, it’s hard to believe these liabilities pose much threat. Having said that, it’s clear that we should continue to monitor its balance sheet, lest it change for the worse.
We measure a company’s debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Marvell Technology shareholders face the double whammy of a high net debt to EBITDA ratio (5.9), and fairly weak interest coverage, since EBIT is just 0.82 times the interest expense. The debt burden here is substantial. However, the silver lining was that Marvell Technology achieved a positive EBIT of US$70m in the last twelve months, an improvement on the prior year’s loss. There’s no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Marvell Technology 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. So it’s worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. Happily for any shareholders, Marvell Technology actually produced more free cash flow than EBIT over the last year. There’s nothing better than incoming cash when it comes to staying in your lenders’ good graces.
Our View
We weren’t impressed with Marvell Technology’s net debt to EBITDA, and its interest cover made us cautious. But like a ballerina ending on a perfect pirouette, it has not trouble converting EBIT to free cash flow. When we consider all the factors mentioned above, we do feel a bit cautious about Marvell Technology’s use of debt. While we appreciate debt can enhance returns on equity, we’d suggest that shareholders keep close watch on its debt levels, lest they increase. There’s no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we’ve identified 1 warning sign for Marvell Technology that you should be aware of.
If you’re interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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