Lam Research (NASDAQ:LRCX) Seems To Use Debt Quite Sensibly

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' 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. We can see that Lam Research Corporation (NASDAQ:LRCX) does use debt in its business. But should shareholders be worried about its use of debt?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. 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.

Check out our latest analysis for Lam Research

What Is Lam Research's Net Debt?

As you can see below, Lam Research had US$4.97b of debt, at June 2024, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds US$5.85b in cash, so it actually has US$880.5m net cash.

How Healthy Is Lam Research's Balance Sheet?

The latest balance sheet data shows that Lam Research had liabilities of US$4.34b due within a year, and liabilities of US$5.87b falling due after that. Offsetting these obligations, it had cash of US$5.85b as well as receivables valued at US$2.52b due within 12 months. So its liabilities total US$1.84b more than the combination of its cash and short-term receivables.

This state of affairs indicates that Lam Research's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the US$106.4b company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Lam Research also has more cash than debt, so we're pretty confident it can manage its debt safely.

On the other hand, Lam Research's EBIT dived 18%, over the last year. If that rate of decline in earnings continues, the company could find itself in a tight spot. 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 Lam Research'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Lam Research 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. Over the most recent three years, Lam Research recorded free cash flow worth 77% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing Up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Lam Research has US$880.5m in net cash. The cherry on top was that in converted 77% of that EBIT to free cash flow, bringing in US$4.3b. 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.