Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that ‘Volatility is far from synonymous with risk.’ So it seems the smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess how risky a company is. Importantly, Synaptics Incorporated (NASDAQ:SYNA) does carry debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Synaptics’s Net Debt?
As you can see below, at the end of March 2021, Synaptics had US$895.3m of debt, up from US$482.0m a year ago. Click the image for more detail. However, it does have US$756.2m in cash offsetting this, leading to net debt of about US$139.1m.
How Strong Is Synaptics’ Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Synaptics had liabilities of US$276.1m due within 12 months and liabilities of US$972.3m due beyond that. Offsetting this, it had US$756.2m in cash and US$234.3m in receivables that were due within 12 months. So it has liabilities totalling US$257.9m more than its cash and near-term receivables, combined.
Of course, Synaptics has a market capitalization of US$5.17b, so these liabilities are probably manageable. Having said that, it’s clear that we should continue to monitor its balance sheet, lest it change for the worse.
We measure a company’s debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Looking at its net debt to EBITDA of 0.61 and interest cover of 5.2 times, it seems to us that Synaptics is probably using debt in a pretty reasonable way. So we’d recommend keeping a close eye on the impact financing costs are having on the business. Notably, Synaptics’s EBIT launched higher than Elon Musk, gaining a whopping 102% on last year. 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 Synaptics’s ability to maintain a healthy balance sheet going forward. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. 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 generation warms our hearts like a puppy in a bumblebee suit.
The good news is that Synaptics’s demonstrated ability to convert EBIT to free cash flow delights us like a fluffy puppy does a toddler. And the good news does not stop there, as its EBIT growth rate also supports that impression! Overall, we don’t think Synaptics is taking any bad risks, as its debt load seems modest. So the balance sheet looks pretty healthy, to us. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet.