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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett said “volatility is far from risk.” So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. We notice that ON Semiconductor Corporation (NASDAQ: ON) has debt on its balance sheet. But the real question is whether this debt makes the business risky.
What risk does debt entail?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. Of course, debt can be an important tool in businesses, especially capital intensive businesses. When we look at debt levels, we first look at cash and debt levels, together.
See our latest review for ON Semiconductor
How much debt is ON Semiconductor?
The image below, which you can click for more details, shows ON Semiconductor owed $ 3.11 billion in debt at the end of October 2021, down from $ 4.24 billion. US over one year. However, given that it has a cash reserve of US $ 1.39 billion, its net debt is less, at around US $ 1.72 billion.
How strong is ON Semiconductor’s balance sheet?
According to the latest published balance sheet, ON Semiconductor had liabilities of US $ 1.44 billion due within 12 months and liabilities of US $ 3.35 billion due beyond 12 months. In compensation for these obligations, he had cash of US $ 1.39 billion as well as receivables valued at US $ 720.0 million within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by US $ 2.69 billion.
Given that listed ON Semiconductor stocks are worth a very impressive US $ 26.7 billion total, it seems unlikely that this level of liabilities is a major threat. But there are enough liabilities that we would certainly recommend that shareholders continue to monitor the balance sheet going forward.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). Thus, we look at debt versus earnings with and without amortization expenses.
ON Semiconductor has net debt of only 1.0 times EBITDA, indicating that it is certainly not a reckless borrower. And it has 7.6 times interest coverage, which is more than enough. Best of all, ON Semiconductor increased its EBIT 172% last year, which is an impressive improvement. If sustained, this growth will make debt even more manageable in the years to come. There is no doubt that we learn the most about debt from the balance sheet. But ultimately, the company’s future profitability will decide whether ON Semiconductor can strengthen its balance sheet over time. So, if you want to see what the professionals think, you might find this free Analyst Profit Forecast report interesting.
Finally, a business can only pay off its debts with hard cash, not with book profits. It is therefore worth checking to what extent this EBIT is supported by free cash flow. Over the past three years, ON Semiconductor has recorded free cash flow of 75% of its EBIT, which is close to normal given that free cash flow excludes interest and taxes. This free cash flow puts the business in a good position to repay debt, if any.
Our point of view
Fortunately, ON Semiconductor’s impressive EBIT growth rate means it has the upper hand on its debt. And the good news does not end there, since its conversion of EBIT into free cash flow also confirms this impression! Zooming out, ON Semiconductor appears to be using debt quite reasonably; and that gets the nod from us. After all, reasonable leverage can increase returns on equity. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. For example, we have identified 3 warning signs for ON Semiconductor that you need to be aware of.
At the end of the day, sometimes it’s easier to focus on businesses that don’t even need to go into debt. Readers can access a list of growth stocks with zero net debt 100% free, at present.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only 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 into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in any of the stocks mentioned.
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