Here's Why Lam Research (NASDAQ:LRCX) Can Manage Its Debt Responsibly

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 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 note that Lam Research Corporation (NASDAQ:LRCX) does have debt on its balance sheet. 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. If things get really bad, the lenders can take control of the business. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Lam Research

What Is Lam Research's Debt?

As you can see below, Lam Research had US$4.98b of debt, at March 2024, which is about the same as the year before. You can click the chart for greater detail. However, it does have US$5.67b in cash offsetting this, leading to net cash of US$688.8m.

How Healthy Is Lam Research's Balance Sheet?

The latest balance sheet data shows that Lam Research had liabilities of US$4.43b due within a year, and liabilities of US$5.83b falling due after that. Offsetting these obligations, it had cash of US$5.67b as well as receivables valued at US$2.20b due within 12 months. So its liabilities total US$2.38b more than the combination of its cash and short-term receivables.

Having regard to Lam Research's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the US$120.6b company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Lam Research boasts net cash, so it's fair to say it does not have a heavy debt load!

The modesty of its debt load may become crucial for Lam Research if management cannot prevent a repeat of the 31% cut to EBIT over the last year. 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 ultimately the future profitability of the business will decide if Lam Research can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Lam Research 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. During the last three years, Lam Research produced sturdy free cash flow equating to 79% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Summing Up

We could understand if investors are concerned about Lam Research's liabilities, but we can be reassured by the fact it has has net cash of US$688.8m. And it impressed us with free cash flow of US$4.5b, being 79% of its EBIT. So we don't have any problem with Lam Research's use of debt. Of course, we wouldn't say no to the extra confidence that we'd gain if we knew that Lam Research insiders have been buying shares: if you're on the same wavelength, you can find out if insiders are buying by clicking this link.

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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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.