STMicroelectronics (EPA:STMPA) Seems To Use Debt Quite Sensibly

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. As with many other companies STMicroelectronics N.V. (EPA:STMPA) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for STMicroelectronics

What Is STMicroelectronics's Debt?

The image below, which you can click on for greater detail, shows that at March 2024 STMicroelectronics had debt of US$3.05b, up from US$2.60b in one year. However, it does have US$6.24b in cash offsetting this, leading to net cash of US$3.19b.

A Look At STMicroelectronics' Liabilities

The latest balance sheet data shows that STMicroelectronics had liabilities of US$3.57b due within a year, and liabilities of US$4.21b falling due after that. On the other hand, it had cash of US$6.24b and US$2.67b worth of receivables due within a year. So it can boast US$1.14b more liquid assets than total liabilities.

This surplus suggests that STMicroelectronics has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that STMicroelectronics has more cash than debt is arguably a good indication that it can manage its debt safely.

On the other hand, STMicroelectronics's EBIT dived 18%, over the last year. We think hat kind of performance, if repeated frequently, could well lead to difficulties for the stock. When analysing debt levels, the balance sheet is the obvious place to start. 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 want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. STMicroelectronics may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Looking at the most recent three years, STMicroelectronics recorded free cash flow of 30% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that STMicroelectronics has net cash of US$3.19b, as well as more liquid assets than liabilities. So we are not troubled with STMicroelectronics's debt use. 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. For example - STMicroelectronics has 1 warning sign we think 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.

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