Stock Analysis

Illumina (NASDAQ:ILMN) Has A Pretty Healthy Balance Sheet

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Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. As with many other companies Illumina, Inc. (NASDAQ:ILMN) makes use of debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

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How Much Debt Does Illumina Carry?

You can click the graphic below for the historical numbers, but it shows that as of July 2021 Illumina had US$1.68b of debt, an increase on US$1.16b, over one year. However, its balance sheet shows it holds US$4.29b in cash, so it actually has US$2.61b net cash.

NasdaqGS:ILMN Debt to Equity History August 17th 2021

How Strong Is Illumina's Balance Sheet?

According to the last reported balance sheet, Illumina had liabilities of US$874.0m due within 12 months, and liabilities of US$2.62b due beyond 12 months. Offsetting this, it had US$4.29b in cash and US$540.0m in receivables that were due within 12 months. So it can boast US$1.33b more liquid assets than total liabilities.

This state of affairs indicates that Illumina's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the US$77.0b company is short on cash, but still worth keeping an eye on the balance sheet. Succinctly put, Illumina boasts net cash, so it's fair to say it does not have a heavy debt load!

In fact Illumina's saving grace is its low debt levels, because its EBIT has tanked 34% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. 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 Illumina'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. 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 actually produced more free cash flow than EBIT. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to investigate a company's debt, in this case Illumina has US$2.61b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$898m, being 106% of its EBIT. So we don't have any problem with Illumina's use of debt. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Illumina that you should be aware of.

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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