David Iben put it well when he said, ‘Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. As with many other companies Illumina, Inc. (NASDAQ:ILMN) makes use of debt. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well – and to its own advantage. The first step when considering a company’s debt levels is to consider its cash and debt together.
What Is Illumina’s Net Debt?
The image below, which you can click on for greater detail, shows that at September 2019 Illumina had debt of US$1.13b, up from US$2.0k in one year. But on the other hand it also has US$3.17b in cash, leading to a US$2.04b net cash position.
How Strong Is Illumina’s Balance Sheet?
We can see from the most recent balance sheet that Illumina had liabilities of US$619.0m falling due within a year, and liabilities of US$2.03b due beyond that. On the other hand, it had cash of US$3.17b and US$541.0m worth of receivables due within a year. So it can boast US$1.06b more liquid assets than total liabilities.
This short term liquidity is a sign that Illumina could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Illumina boasts net cash, so it’s fair to say it does not have a heavy debt load!
While Illumina doesn’t seem to have gained much on the EBIT line, at least earnings remain stable for now.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Illumina may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Illumina recorded free cash flow worth a fulsome 86% of its EBIT, which is stronger than we’d usually expect. That positions it well to pay down debt if desirable to do so.
While it is always sensible to investigate a company’s debt, in this case Illumina has US$2.04b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$691m, being 86% of its EBIT. So we don’t think Illumina’s use of debt is risky. Over time, share prices tend to follow earnings per share, so if you’re interested in Illumina, you may well want to click here to check an interactive graph of its earnings per share history.
At the end of the day, it’s often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It’s free.
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