Stock Analysis

Is II-VI (NASDAQ:IIVI) A Risky Investment?

NYSE:COHR
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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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that II-VI Incorporated (NASDAQ:IIVI) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

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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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for II-VI

What Is II-VI's Net Debt?

You can click the graphic below for the historical numbers, but it shows that II-VI had US$1.51b of debt in December 2020, down from US$2.30b, one year before. However, it also had US$834.5m in cash, and so its net debt is US$678.1m.

debt-equity-history-analysis
NasdaqGS:IIVI Debt to Equity History March 13th 2021

A Look At II-VI's Liabilities

Zooming in on the latest balance sheet data, we can see that II-VI had liabilities of US$664.5m due within 12 months and liabilities of US$1.75b due beyond that. Offsetting this, it had US$834.5m in cash and US$571.0m in receivables that were due within 12 months. So it has liabilities totalling US$1.00b more than its cash and near-term receivables, combined.

Since publicly traded II-VI shares are worth a total of US$8.02b, it seems unlikely that this level of liabilities would be a major threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Looking at its net debt to EBITDA of 1.1 and interest cover of 4.2 times, it seems to us that II-VI is probably using debt in a pretty reasonable way. But the interest payments are certainly sufficient to have us thinking about how affordable its debt is. Pleasingly, II-VI is growing its EBIT faster than former Australian PM Bob Hawke downs a yard glass, boasting a 210% gain in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if II-VI 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Over the most recent three years, II-VI recorded free cash flow worth 78% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

The good news is that II-VI's demonstrated ability to grow its EBIT delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its interest cover. Looking at the bigger picture, we think II-VI's use of debt seems quite reasonable and we're not concerned about it. After all, sensible leverage can boost returns on equity. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 3 warning signs for II-VI that you should be aware of.

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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This article by Simply Wall St is general in nature. 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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About NYSE:COHR

Coherent

Develops, manufactures, and markets engineered materials, optoelectronic components and devices, and optical and laser systems and subsystems for the use in the industrial, communications, electronics, and instrumentation markets worldwide.

Reasonable growth potential and fair value.

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