David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Himax Technologies, Inc. (NASDAQ:HIMX) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we examine debt levels, we first consider both cash and debt levels, together.

How Much Debt Does Himax Technologies Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2023 Himax Technologies had US$493.5m of debt, an increase on US$415.8m, over one year. However, it does have US$206.4m in cash offsetting this, leading to net debt of about US$287.1m.

How Strong Is Himax Technologies' Balance Sheet?

We can see from the most recent balance sheet that Himax Technologies had liabilities of US$708.8m falling due within a year, and liabilities of US$70.9m due beyond that. Offsetting these obligations, it had cash of US$206.4m as well as receivables valued at US$237.4m due within 12 months. So it has liabilities totalling US$336.0m more than its cash and near-term receivables, combined.

Himax Technologies has a market capitalization of US$927.9m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Himax Technologies's net debt is 4.5 times its EBITDA, which is a significant but still reasonable amount of leverage. However, its interest coverage of 1k is very high, suggesting that the interest expense on the debt is currently quite low. Shareholders should be aware that Himax Technologies's EBIT was down 83% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. 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 Himax Technologies'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. So we always check how much of that EBIT is translated into free cash flow. Over the most recent three years, Himax Technologies recorded free cash flow worth 69% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

Himax Technologies's EBIT growth rate and net debt to EBITDA definitely weigh on it, in our esteem. But the good news is it seems to be able to cover its interest expense with its EBIT with ease. We think that Himax Technologies's debt does make it a bit risky, after considering the aforementioned data points together. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. Case in point: We've spotted 2 warning signs for Himax Technologies you should be aware of.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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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.