These 4 Measures Indicate That II-VI (NASDAQ:IIVI) Is Using Debt Safely

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says '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. We can see that II-VI Incorporated (NASDAQ:IIVI) does use debt in its business. But is this debt a concern to shareholders?

When Is Debt Dangerous?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. 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?

As you can see below, II-VI had US$1.40b of debt at September 2021, down from US$1.53b a year prior. But on the other hand it also has US$1.56b in cash, leading to a US$158.8m net cash position.

A Look At II-VI's Liabilities

We can see from the most recent balance sheet that II-VI had liabilities of US$1.03b falling due within a year, 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.

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$7.00b company is short on cash, but still worth keeping an eye on the 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.

Even more impressive was the fact that II-VI grew its EBIT by 114% over twelve months. If maintained that growth will make the debt even more manageable in the years ahead. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine II-VI'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 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 85% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.

Summing up

We could understand if investors are concerned about II-VI's liabilities, but we can be reassured by the fact it has has net cash of US$158.8m. And it impressed us with free cash flow of US$332m, being 85% of its EBIT. So is II-VI's debt a risk? It doesn't seem so to us. 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. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for II-VI you should know about.

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. 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.