X-FAB Silicon Foundries (EPA:XFAB) Could Easily Take On More Debt

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.' 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, X-FAB Silicon Foundries SE (EPA:XFAB) does carry debt. But is this debt a concern to shareholders?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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.

See our latest analysis for X-FAB Silicon Foundries

What Is X-FAB Silicon Foundries's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2022 X-FAB Silicon Foundries had debt of US$129.9m, up from US$65.7m in one year. But on the other hand it also has US$259.3m in cash, leading to a US$129.4m net cash position.

How Healthy Is X-FAB Silicon Foundries' Balance Sheet?

The latest balance sheet data shows that X-FAB Silicon Foundries had liabilities of US$199.5m due within a year, and liabilities of US$42.6m falling due after that. Offsetting this, it had US$259.3m in cash and US$75.0m in receivables that were due within 12 months. So it can boast US$92.2m more liquid assets than total liabilities.

This short term liquidity is a sign that X-FAB Silicon Foundries could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that X-FAB Silicon Foundries has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, X-FAB Silicon Foundries grew its EBIT by 11,090% last year, which is an impressive improvement. That boost will make it even easier to pay down debt going forward. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if X-FAB Silicon Foundries can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. X-FAB Silicon Foundries 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 two years, X-FAB Silicon Foundries recorded free cash flow of 48% 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 X-FAB Silicon Foundries has net cash of US$129.4m, as well as more liquid assets than liabilities. And we liked the look of last year's 11,090% year-on-year EBIT growth. So we don't think X-FAB Silicon Foundries's use of debt is risky. Above most other metrics, we think its important to track how fast earnings per share is growing, if at all. If you've also come to that realization, you're in luck, because today you can view this interactive graph of X-FAB Silicon Foundries's earnings per share history for free.

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.