Is STMicroelectronics (EPA:STM) A Risky Investment?

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 can see that STMicroelectronics N.V. (EPA:STM) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt Dangerous?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for STMicroelectronics

What Is STMicroelectronics's Debt?

You can click the graphic below for the historical numbers, but it shows that as of December 2022 STMicroelectronics had US$2.66b of debt, an increase on US$2.54b, over one year. But it also has US$4.52b in cash to offset that, meaning it has US$1.86b net cash.

A Look At STMicroelectronics' Liabilities

We can see from the most recent balance sheet that STMicroelectronics had liabilities of US$3.84b falling due within a year, and liabilities of US$3.39b due beyond that. Offsetting these obligations, it had cash of US$4.52b as well as receivables valued at US$2.46b due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$244.0m.

This state of affairs indicates that STMicroelectronics' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the US$42.7b company is short on cash, but still worth keeping an eye on the balance sheet. While it does have liabilities worth noting, STMicroelectronics also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, STMicroelectronics grew its EBIT by 83% 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 ultimately the future profitability of the business will decide if STMicroelectronics can strengthen its balance sheet over time. 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 42% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that STMicroelectronics has US$1.86b in net cash. And it impressed us with its EBIT growth of 83% over the last year. So is STMicroelectronics's debt a risk? It doesn't seem so to us. 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 1 warning sign for STMicroelectronics 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.

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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.