Is Soitec (EPA:SOI) A Risky Investment?

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, Soitec S.A. (EPA:SOI) does carry debt. But the real question is whether this debt is making the company risky.

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Soitec

What Is Soitec's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2021 Soitec had €587.0m of debt, an increase on €246.2m, over one year. However, it does have €592.3m in cash offsetting this, leading to net cash of €5.28m.

A Look At Soitec's Liabilities

The latest balance sheet data shows that Soitec had liabilities of €392.6m due within a year, and liabilities of €509.0m falling due after that. On the other hand, it had cash of €592.3m and €265.6m worth of receivables due within a year. So it has liabilities totalling €43.6m more than its cash and near-term receivables, combined.

Having regard to Soitec's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the €5.35b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Soitec boasts net cash, so it's fair to say it does not have a heavy debt load!

Another good sign is that Soitec has been able to increase its EBIT by 23% in twelve months, making it easier to pay down debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Soitec'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Soitec 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. In the last three years, Soitec created free cash flow amounting to 3.1% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Soitec has €5.28m in net cash. And we liked the look of last year's 23% year-on-year EBIT growth. So we are not troubled with Soitec's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example Soitec has 3 warning signs (and 1 which shouldn't be ignored) we think you should know about.

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.