Is Semiconductor Manufacturing International (HKG:981) A Risky Investment?

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.' 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. We note that Semiconductor Manufacturing International Corporation (HKG:981) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free 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, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Semiconductor Manufacturing International

What Is Semiconductor Manufacturing International's Net Debt?

The image below, which you can click on for greater detail, shows that at June 2022 Semiconductor Manufacturing International had debt of US$7.10b, up from US$5.75b in one year. But on the other hand it also has US$14.9b in cash, leading to a US$7.76b net cash position.

How Healthy Is Semiconductor Manufacturing International's Balance Sheet?

According to the last reported balance sheet, Semiconductor Manufacturing International had liabilities of US$6.34b due within 12 months, and liabilities of US$6.81b due beyond 12 months. Offsetting these obligations, it had cash of US$14.9b as well as receivables valued at US$1.02b due within 12 months. So it can boast US$2.74b more liquid assets than total liabilities.

This surplus suggests that Semiconductor Manufacturing International is using debt in a way that is appears to be both safe and conservative. Given it has easily adequate short term liquidity, we don't think it will have any issues with its lenders. Simply put, the fact that Semiconductor Manufacturing International has more cash than debt is arguably a good indication that it can manage its debt safely.

Better yet, Semiconductor Manufacturing International grew its EBIT by 301% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Semiconductor Manufacturing International 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Semiconductor Manufacturing International 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. Over the last two years, Semiconductor Manufacturing International saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Summing Up

While we empathize with investors who find debt concerning, you should keep in mind that Semiconductor Manufacturing International has net cash of US$7.76b, as well as more liquid assets than liabilities. And it impressed us with its EBIT growth of 301% over the last year. So is Semiconductor Manufacturing International's debt a risk? It doesn't seem so to us. 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. For example Semiconductor Manufacturing International has 2 warning signs (and 1 which shouldn't be ignored) we think you should know about.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.