We Think Semiconductor Manufacturing International (HKG:981) Is Taking Some Risk With Its Debt

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. Importantly, Semiconductor Manufacturing International Corporation (HKG:981) does carry debt. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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.

Check out our latest analysis for Semiconductor Manufacturing International

How Much Debt Does Semiconductor Manufacturing International Carry?

The image below, which you can click on for greater detail, shows that at September 2023 Semiconductor Manufacturing International had debt of US$9.57b, up from US$7.84b in one year. However, it does have US$10.5b in cash offsetting this, leading to net cash of US$958.1m.

How Healthy Is Semiconductor Manufacturing International's Balance Sheet?

According to the last reported balance sheet, Semiconductor Manufacturing International had liabilities of US$8.39b due within 12 months, and liabilities of US$7.78b due beyond 12 months. Offsetting these obligations, it had cash of US$10.5b as well as receivables valued at US$1.22b due within 12 months. So its liabilities total US$4.42b more than the combination of its cash and short-term receivables.

Of course, Semiconductor Manufacturing International has a titanic market capitalization of US$25.8b, so these liabilities are probably manageable. 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, Semiconductor Manufacturing International also has more cash than debt, so we're pretty confident it can manage its debt safely.

It is just as well that Semiconductor Manufacturing International's load is not too heavy, because its EBIT was down 94% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Semiconductor Manufacturing International'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.

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 three 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 Semiconductor Manufacturing International does have more liabilities than liquid assets, it also has net cash of US$958.1m. So while Semiconductor Manufacturing International does not have a great balance sheet, it's certainly not too bad. 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. We've identified 3 warning signs with Semiconductor Manufacturing International (at least 2 which are a bit concerning) , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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.