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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.’ 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. As with many other companies Enphase Energy, Inc. (NASDAQ:ENPH) makes use of debt. But the more important question is: how much risk is that debt creating?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company’s debt levels is to consider its cash and debt together.

Check out our latest analysis for Enphase Energy

What Is Enphase Energy’s Net Debt?

As you can see below, at the end of September 2021, Enphase Energy had US$1.03b of debt, up from US$360.1m a year ago. Click the image for more detail. But on the other hand it also has US$1.39b in cash, leading to a US$367.8m net cash position.

debt-equity-history-analysis

How Strong Is Enphase Energy’s Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Enphase Energy had liabilities of US$393.5m due within 12 months and liabilities of US$1.19b due beyond that. On the other hand, it had cash of US$1.39b and US$295.5m worth of receivables due within a year. So it actually has US$107.2m more liquid assets than total liabilities.

Having regard to Enphase Energy’s size, it seems that its liquid assets are well balanced with its total liabilities. So it’s very unlikely that the US$35.2b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Enphase Energy boasts net cash, so it’s fair to say it does not have a heavy debt load!

On top of that, Enphase Energy grew its EBIT by 58% 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 it is future earnings, more than anything, that will determine Enphase Energy’s ability to maintain a healthy balance sheet going forward. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. While Enphase Energy has net cash on its balance sheet, it’s still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the last three years, Enphase Energy actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While we empathize with investors who find debt concerning, you should keep in mind that Enphase Energy has net cash of US$367.8m, as well as more liquid assets than liabilities. The cherry on top was that in converted 116% of that EBIT to free cash flow, bringing in US$291m. So we don’t think Enphase Energy’s use of debt is risky. There’s no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet – far from it. These risks can be hard to spot. Every company has them, and we’ve spotted 5 warning signs for Enphase Energy you should know about.

At the end of the day, it’s often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It’s free.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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