Here's Why IQE (LON:IQE) Can Manage Its Debt Responsibly

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 IQE plc (LON:IQE) makes use of debt. But should shareholders be worried about its use of debt?

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. 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. 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. 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 IQE

How Much Debt Does IQE Carry?

As you can see below, IQE had UK£22.7m of debt at December 2020, down from UK£24.8m a year prior. But it also has UK£24.7m in cash to offset that, meaning it has UK£1.92m net cash.

How Healthy Is IQE's Balance Sheet?

According to the last reported balance sheet, IQE had liabilities of UK£48.5m due within 12 months, and liabilities of UK£62.3m due beyond 12 months. On the other hand, it had cash of UK£24.7m and UK£35.1m worth of receivables due within a year. So it has liabilities totalling UK£51.1m more than its cash and near-term receivables, combined.

Given IQE has a market capitalization of UK£436.7m, it's hard to believe these liabilities pose much threat. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, IQE also has more cash than debt, so we're pretty confident it can manage its debt safely.

We also note that IQE improved its EBIT from a last year's loss to a positive UK£3.5m. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if IQE 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 IQE 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. Happily for any shareholders, IQE actually produced more free cash flow than EBIT over the last year. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While IQE does have more liabilities than liquid assets, it also has net cash of UK£1.92m. The cherry on top was that in converted 662% of that EBIT to free cash flow, bringing in UK£23m. So we don't have any problem with IQE's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for IQE you should know about.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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