The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. We can see that First Solar, Inc. (NASDAQ:FSLR) does use debt in its business. But the more important question is: how much risk is that debt creating?
Why Does Debt Bring Risk?
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 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is First Solar's Net Debt?
You can click the graphic below for the historical numbers, but it shows that First Solar had US$260.9m of debt in September 2020, down from US$489.5m, one year before. But it also has US$1.63b in cash to offset that, meaning it has US$1.37b net cash.
A Look At First Solar's Liabilities
We can see from the most recent balance sheet that First Solar had liabilities of US$731.1m falling due within a year, and liabilities of US$858.0m due beyond that. Offsetting this, it had US$1.63b in cash and US$310.5m in receivables that were due within 12 months. So it can boast US$352.2m more liquid assets than total liabilities.
This short term liquidity is a sign that First Solar could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, First Solar boasts net cash, so it's fair to say it does not have a heavy debt load!
It was also good to see that despite losing money on the EBIT line last year, First Solar turned things around in the last 12 months, delivering and EBIT of US$541m. 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 First Solar'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 company can only pay off debt with cold hard cash, not accounting profits. While First Solar has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Looking at the most recent year, First Solar recorded free cash flow of 27% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
While we empathize with investors who find debt concerning, you should keep in mind that First Solar has net cash of US$1.37b, as well as more liquid assets than liabilities. So we are not troubled with First Solar's debt use. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 4 warning signs for First Solar (1 is potentially serious) you should be aware of.
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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