Is STMicroelectronics (EPA:STM) Using Too Much Debt?

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. 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. Importantly, STMicroelectronics N.V. (EPA:STM) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for STMicroelectronics

What Is STMicroelectronics's Net Debt?

The image below, which you can click on for greater detail, shows that at September 2019 STMicroelectronics had debt of US$2.19b, up from US$1.7k in one year. But it also has US$2.48b in cash to offset that, meaning it has US$288.0m net cash.

A Look At STMicroelectronics's Liabilities

Zooming in on the latest balance sheet data, we can see that STMicroelectronics had liabilities of US$2.13b due within 12 months and liabilities of US$2.74b due beyond that. Offsetting these obligations, it had cash of US$2.48b as well as receivables valued at US$1.39b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$1.00b.

Given STMicroelectronics has a humongous market capitalization of US$24.9b, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. Despite its noteworthy liabilities, STMicroelectronics boasts net cash, so it's fair to say it does not have a heavy debt load!

On the other hand, STMicroelectronics's EBIT dived 14%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. 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 STMicroelectronics'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 company can only pay off debt with cold hard cash, not accounting profits. While STMicroelectronics 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. Looking at the most recent three years, STMicroelectronics recorded free cash flow of 32% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that STMicroelectronics has US$288.0m in net cash. So we are not troubled with STMicroelectronics's debt use. 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. For instance, we've identified 1 warning sign for STMicroelectronics that 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.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.