Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies II-VI Incorporated (NASDAQ:IIVI) makes use of debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
What Is II-VI's Debt?
The image below, which you can click on for greater detail, shows that II-VI had debt of US$1.38b at the end of June 2021, a reduction from US$2.26b over a year. But it also has US$1.59b in cash to offset that, meaning it has US$216.8m net cash.
A Look At II-VI's Liabilities
We can see from the most recent balance sheet that II-VI had liabilities of US$729.6m falling due within a year, and liabilities of US$1.65b due beyond that. Offsetting these obligations, it had cash of US$1.59b as well as receivables valued at US$659.0m due within 12 months. So it has liabilities totalling US$129.4m more than its cash and near-term receivables, combined.
Having regard to II-VI's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the US$6.50b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, II-VI boasts net cash, so it's fair to say it does not have a heavy debt load!
Even more impressive was the fact that II-VI grew its EBIT by 218% over twelve months. 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 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. While II-VI 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. During the last three years, II-VI generated free cash flow amounting to a very robust 93% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
While it is always sensible to look at a company's total liabilities, it is very reassuring that II-VI has US$216.8m in net cash. And it impressed us with free cash flow of US$428m, being 93% of its EBIT. So we don't think II-VI's use of debt is risky. 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. For example, we've discovered 1 warning sign for II-VI that you should be aware of before investing here.
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.
What are the risks and opportunities for Coherent?
Earnings are forecast to grow 122.54% per year
Interest payments are not well covered by earnings
Shareholders have been diluted in the past year
Profit margins (0.9%) are lower than last year (8.8%)
Large one-off items impacting financial results
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.
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