Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. 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. As with many other companies Silicon Laboratories Inc. (NASDAQ:SLAB) makes use of debt. But the real question is whether this debt is making the company risky.
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. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Silicon Laboratories Carry?
The image below, which you can click on for greater detail, shows that at April 2020 Silicon Laboratories had debt of US$664.1m, up from US$358.1m in one year. However, it does have US$1.06b in cash offsetting this, leading to net cash of US$394.2m.
A Look At Silicon Laboratories's Liabilities
According to the last reported balance sheet, Silicon Laboratories had liabilities of US$446.7m due within 12 months, and liabilities of US$424.7m due beyond 12 months. Offsetting these obligations, it had cash of US$1.06b as well as receivables valued at US$74.6m due within 12 months. So it actually has US$261.4m more liquid assets than total liabilities.
This short term liquidity is a sign that Silicon Laboratories could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Silicon Laboratories has more cash than debt is arguably a good indication that it can manage its debt safely.
In fact Silicon Laboratories's saving grace is its low debt levels, because its EBIT has tanked 24% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Silicon Laboratories'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.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. Silicon Laboratories 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, Silicon Laboratories actually produced more free cash flow than EBIT. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.
While we empathize with investors who find debt concerning, you should keep in mind that Silicon Laboratories has net cash of US$394.2m, as well as more liquid assets than liabilities. And it impressed us with free cash flow of US$178m, being 221% of its EBIT. So we are not troubled with Silicon Laboratories's debt use. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 3 warning signs for Silicon Laboratories that you should be aware of.
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. 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. Thank you for reading.