We Think II-VI (NASDAQ:IIVI) Can Manage Its Debt With Ease

Warren Buffett famously said, '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 is this debt a concern to shareholders?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for II-VI

What Is II-VI's Debt?

You can click the graphic below for the historical numbers, but it shows that II-VI had US$1.40b of debt in September 2021, down from US$1.53b, one year before. However, its balance sheet shows it holds US$1.56b in cash, so it actually has US$158.8m net cash.

How Strong Is II-VI's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that II-VI had liabilities of US$1.03b due within 12 months and liabilities of US$1.29b due beyond that. Offsetting these obligations, it had cash of US$1.56b as well as receivables valued at US$663.9m due within 12 months. So its liabilities total US$97.4m more than the combination of its cash and short-term receivables.

This state of affairs indicates that II-VI's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$6.89b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, II-VI also has more cash than debt, so we're pretty confident it can manage its debt safely.

Better yet, II-VI grew its EBIT by 114% 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 II-VI 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. 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. Over the last three years, II-VI recorded free cash flow worth a fulsome 85% of its EBIT, which is stronger than we'd usually expect. That positions it well to pay down debt if desirable to do so.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that II-VI has US$158.8m in net cash. And it impressed us with free cash flow of US$332m, being 85% of its EBIT. So we don't think II-VI's use of debt is risky. 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. Be aware that II-VI is showing 2 warning signs in our investment analysis , you should know about...

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.