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.' 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 note that Soitec S.A. (EPA:SOI) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Soitec Carry?
You can click the graphic below for the historical numbers, but it shows that as of September 2020 Soitec had €246.2m of debt, an increase on €178.2m, over one year. However, its balance sheet shows it holds €300.2m in cash, so it actually has €53.9m net cash.
How Healthy Is Soitec's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Soitec had liabilities of €225.4m due within 12 months and liabilities of €297.4m due beyond that. Offsetting these obligations, it had cash of €300.2m as well as receivables valued at €164.4m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by €58.3m.
This state of affairs indicates that Soitec's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the €5.47b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, Soitec also has more cash than debt, so we're pretty confident it can manage its debt safely.
On the other hand, Soitec's EBIT dived 12%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. 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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. 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. Over the last three years, Soitec reported free cash flow worth 7.9% of its EBIT, which is really quite low. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Soitec has €53.9m in net cash. So we are not troubled with Soitec's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Soitec that you should be aware of before investing here.
Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.
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