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 synonymous with risk.” So it seems smart money knows that debt – which is usually involved in bankruptcies – is a very important factor when you’re assessing a company’s risk. We note that Skyworks Solutions, Inc. (NASDAQ:SWKS) has debt on its balance sheet. But the more important question is: what risk does this debt create?

What risk does debt carry?

Debt and other liabilities become risky for a business when it cannot easily meet those obligations, either with free cash flow or by raising capital at an attractive price. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more common (but still costly) situation is when a company has to dilute shareholders at a cheap share price just to keep debt under control. Of course, the advantage of debt is that it often represents cheap capital, especially when it replaces dilution in a business with the ability to reinvest at high rates of return. When we look at debt levels, we first consider cash and debt levels, together.

See our latest analysis for Skyworks Solutions

What is Skyworks Solutions debt?

The image below, which you can click on for more details, shows that in December 2021, Skyworks Solutions had US$2.19 billion in debt, up from none in a year. However, since he has a cash reserve of $1.01 billion, his net debt is less, at around $1.17 billion.

How strong is Skyworks Solutions’ balance sheet?

We can see from the most recent balance sheet that Skyworks Solutions had liabilities of US$681.9 million due in one year, and liabilities of US$2.60 billion due beyond. As compensation for these obligations, it had cash of US$1.01 billion and receivables valued at US$774.0 million due within 12 months. It therefore has liabilities totaling $1.50 billion more than its cash and short-term receivables, combined.

Of course, Skyworks Solutions has a titanic market capitalization of US$21.3 billion, so those liabilities are probably manageable. That said, it is clear that we must continue to monitor its record, lest it deteriorate.

We measure a company’s leverage against its earning power by looking at its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and calculating how easily its earnings before interest and taxes (EBIT ) covers its interest charge (interest coverage). Thus, we consider debt to earnings with and without amortization and depreciation expense.

Skyworks Solutions’ net debt is only 0.59 times its EBITDA. And its EBIT easily covers its interest costs, which is 66.4 times the size. One could therefore say that he is no more threatened by his debt than an elephant is by a mouse. Another good sign, Skyworks Solutions was able to increase its EBIT by 29% in twelve months, thus facilitating the repayment of its debt. When analyzing debt levels, the balance sheet is the obvious starting point. But it is future earnings, more than anything, that will determine Skyworks Solutions’ ability to maintain a healthy balance sheet in the future. So if you are focused on the future, you can check out this free report showing analyst earnings forecast.

Finally, while the taxman may love accounting profits, lenders only accept cash. So the logical step is to look at what proportion of that EBIT is actual free cash flow. Over the past three years, Skyworks Solutions has recorded free cash flow of 79% of its EBIT, which is about normal, given that free cash flow excludes interest and taxes. This free cash flow puts the company in a good position to repay its debt, should it arise.

Our point of view

The good news is that Skyworks Solutions’ demonstrated ability to cover interest costs with EBIT delights us like a fluffy puppy does a toddler. And the good news doesn’t stop there, since its conversion of EBIT into free cash flow also confirms this impression! We believe Skyworks Solutions is no more indebted to its lenders than birds are to bird watchers. For investment nerds like us, his track record is almost charming. The balance sheet is clearly the area to focus on when analyzing debt. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, we have identified 1 warning sign for Skyworks Solutions of which you should be aware.

Of course, if you’re the type of investor who prefers to buy stocks without the burden of debt, then feel free to check out our exclusive list of cash-efficient growth stocks today.

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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.