Howard Marks put it nicely when he said that, rather than worrying about share price volatility, ‘The possibility of permanent loss is the risk I worry about… and every practical investor I know worries about.’ It’s only natural to consider a company’s balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Synaptics Incorporated (NASDAQ:SYNA) does carry debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

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. Ultimately, if the company can’t fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

How Much Debt Does Synaptics Carry?

The image below, which you can click on for greater detail, shows that at September 2022 Synaptics had debt of US$980.8m, up from US$394.5m in one year. However, it does have US$911.8m in cash offsetting this, leading to net debt of about US$69.0m.

A Look At Synaptics’ Liabilities

We can see from the most recent balance sheet that Synaptics had liabilities of US$365.3m falling due within a year, and liabilities of US$1.13b due beyond that. Offsetting these obligations, it had cash of US$911.8m as well as receivables valued at US$285.5m due within 12 months. So its liabilities total US$302.4m more than the combination of its cash and short-term receivables.

Of course, Synaptics has a market capitalization of US$4.60b, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward.

In order to size up a company’s debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Synaptics’s net debt is only 0.12 times its EBITDA. And its EBIT easily covers its interest expense, being 15.4 times the size. So we’re pretty relaxed about its super-conservative use of debt. Even more impressive was the fact that Synaptics grew its EBIT by 161% 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 ultimately the future profitability of the business will decide if Synaptics can strengthen its balance sheet over time.

Finally, a business needs free cash flow to pay off debt; accounting profits just don’t cut it. So it’s worth checking how much of that EBIT is backed by free cash flow. Over the last three years, Synaptics actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Our View

The good news is that Synaptics’s demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its conversion of EBIT to free cash flow also supports that impression! We think Synaptics is no more beholden to its lenders, than the birds are to birdwatchers. For investing nerds like us its balance sheet is almost charming.